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Edited Transcript of BAX earnings conference call or presentation 17-Mar-20 12:30pm GMT

Q4 2019 Baxter International Inc Earnings Call

Deerfield Mar 18, 2020 (Thomson StreetEvents) -- Edited Transcript of Baxter International Inc earnings conference call or presentation Tuesday, March 17, 2020 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

* Lawrence Soren Keusch

Raymond James & Associates, Inc., Research Division - MD

* Matthew Charles Taylor

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

* Philip Chickering

Deutsche Bank AG, Research Division - Research Analyst

* Robert Adam Hopkins

BofA Merrill Lynch, Research Division - MD of Equity Research

* Robert Justin Marcus

JP Morgan Chase & Co, Research Division - Analyst

* Vijay Muniyappa Kumar

Evercore ISI Institutional Equities, Research Division - MD

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen, and welcome to the Baxter International Fourth 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 rebroadcasted 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, Catherine. Good morning, and welcome to our fourth 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 fourth quarter and full year 2019 financial results as well as growth comparisons to restated historical financial results as disclosed in today's comprehensive 10-K filings. We will also provide our financial outlook for the first quarter of 2020. A supplemental presentation to complement this morning's discussion can be accessed on our website. This presentation, including related non-GAAP reconciliations, can be accessed on Baxter's external website in the Investors section under Events & News.

With that, let me start our prepared remarks by reminding everyone that this presentation, including comments regarding our financial outlook, new product development, business development and regulatory matters contain forward-looking statements that involve risks and uncertainties. And of course, our actual results could differ materially from our current expectations. Please refer to today's press release and our SEC filings for more 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 U.S. GAAP financial measures is included in our earnings release and available on our website. On the call this morning, we will be discussing operational sales growth, which for historical periods, adjust for the impact of foreign exchange and generic competition for cyclophosphamide in the U.S. Operational sales growth guidance for 2020 adjusts for the impact of foreign exchange and the acquisition of Seprafilm, which closed on February 14 of this year.

Now I'd like to turn the call over to 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. Before Jay and I review financials for the fourth quarter and full year 2019, I want to update you on our internal investigation regarding nonoperating income related to foreign exchange gains and losses. As you know, the company and the Board have taken this matter very seriously. We moved to address it quickly and comprehensively with the help of independent, experienced advisers and forensic accountants. We also communicated proactively to the SEC, and have maintained open dialogue with the commission throughout. As indicated in the press release, our internal investigation is now complete as it relates to the financial statement impacts. This morning, we filed our 2019 Form 10-K, which included audited restated financial statements for full year 2018 and 2017. We also filed our Form 10-Q for the quarter ended September 30, 2019. With these filings, we are now current with our SEC reporting obligations. Jay will discuss in further detail the changes we have made to strengthen and enhance our overall control environment.

Before I shift to a discussion of financial results for the fourth quarter of 2019, I feel it's important to make some comments on the rapidly evolving situation with COVID-19. The coronavirus outbreak continues to challenge communities, relief organizations, health care systems and businesses around the world. At Baxter, we have been active on the front line since its emergence, taking proactive measures to protect employees, aid patients and health care providers affected by the pandemic and maintain global supply of our essential medical products. On the supply front, our manufacturing operations are currently running at planned levels, and our supply chain team is assessing and mitigating possible disruptions around the globe. We are proactively managing our inventory levels, stock levels in warehouses, transportation options and the availability of raw materials and component parts. Given the global nature of the epidemic, we have seen some constraints on a limited number of components and APIS, especially those sourced from China and Italy. At this time, our team has been able to mitigate those disruptions by deploying existing inventory, providing additional support to our suppliers to help them return to production, using alternate shipping methods to expedite delivery and working with additional suppliers where needed. Our own efforts over the last few years to strengthen and expand our manufacturing supply network further support our position. We will continue to work closely with our regional and global supplier networks to address this ever-evolving situation. And our goal remains to help ensure all of our customers have access to the products they need to the best of our ability. To that end, I'd like to acknowledge the extraordinary actions of our 50,000 Baxter colleagues around the world, have been taken to serve patients and clinicians and help ensure access to our life-saving and life-sustaining products. While we will continue to actively monitor this situation and its potential business disruptions, we remain confident in our long-term underlying strength and innovation pipeline. We will also remain vigilant in exploring the most impactful ways to deploy our capital, including compelling business development opportunities as well as returning value directly to our investors.

With that, I will make some brief comments on our 2019 performance. As we shared in early January, our Q4 performance reflected Baxter's strongest operational sales growth since the 2015 Baxalta spinoff. Sales increased 7% on a reported basis, 8% at a constant currency and 9% on an operational basis. All 6 of our global business units and 3 geographic segments contributed to this strong top line performance, which was driven in part by our reinvigorated emphasis on innovation. Advancing our new product pipeline will continue to be a fundamental element of our ongoing transformation.

Our top line performance, combined with a focus on operational excellence and financial discipline, drove adjusted EPS of $0.97, a 37% increase year-over-year. Our fourth quarter performance demonstrated our ability to drive growth across our diversified portfolio by focusing on effectively meeting the needs of patients and providers. Within the quarter, we saw PD patient growth of approximately 7% globally, including low double-digit PD patient growth in the U.S. While we await publication of the final rule from the White House on the Advancing American Kidney Health Initiative, we are actively planning for investments required to increase our U.S. production capacity to meet new patient needs. We anticipate that home PD growth will continue to outpace that of overall ESRD growth.

In addition, during the quarter, we installed more infusion pumps in the U.S. than we have in recent history. Our Spectrum IQ infusion pump has one of the best drug libraries in the world, along with bidirectional EMR integration, and we continue to realize the benefits of innovation across our portfolio. Pharmaceuticals growth in the quarter was enhanced by our growing range of generic injectables. Enhanced momentum in clinical nutrition was fueled in part by our recent OLIMEL N12 and FINOMEL launches. Within Advanced Surgery, we effectively met heightened market demands for FLOSEAL Fast Prep, which launched earlier in 2019. And in Acute Therapies, we continue to successfully roll out our PrisMax platform across geographies. All in all, we are pleased to close out 2019 on such a strong note, and are well positioned for sustained momentum as we remain focused on our long-term strategic objectives.

Now I will pass it on to Jay to provide some additional details on the quarter.

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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 fourth quarter results demonstrate robust operational performance, with solid growth across all 6 global business units and 3 geographic segments.

Throughout the year, we delivered on our goal of growth through innovation and drove further benefits from our ongoing transformation initiatives. Moving into 2020 and beyond, we will continue to execute on our commercial strategies while also investing in several initiatives to support accelerated growth opportunities. As Joe referenced, we've implemented a number of changes to strengthen and enhance our overall internal control environment. Some of these changes, including utilizing exchange rates in accordance with U.S. GAAP, a daily automated feed of foreign exchange rates from a recognized third-party, updated policies on intercompany transaction approvals and select personnel changes, including hiring Karen Leets as our new Treasurer. Karen brings significant treasury experience to Baxter, after having held senior treasury roles at several large corporations. Under her leadership, we've hired another experienced treasury professional in a newly created director role, responsible for treasury governance and controls. Additionally, we've created a treasury controller role within our accounting function, and are continuing to add resources as appropriate to improve our financial reporting controls related to treasury activities. While this was clearly disappointing, we are moving forward and continuing to execute on our strategic objectives in support of our goal to deliver industry-leading performance. And our recent results demonstrate the strength of this ongoing transformation.

Turning to our fourth quarter and full year 2019 results. Beginning with the fourth quarter, global sales of $3 billion increased 7% on a reported basis, 8% on constant currency and 9% operationally. Our performance in the quarter was primarily driven by Pharmaceuticals as well as Medication Delivery and Advanced Surgery, particularly in the United States. On the bottom line, adjusted earnings increased 37% to $0.97 per diluted share as a result of strong operational performance and ongoing benefit from our business transformation efforts and the lower share count.

Now I'll walk you through performance by our geographic segments and global business units. Note that for this quarter, constant currency sales growth is equal to operational sales growth for all businesses and geographic segments, except for our Pharmaceuticals business and the Americas region, for which we will provide operational growth in addition to constant currency growth. Additionally, all growth rates represent comparisons to our restated historical financials published this morning.

Starting with sales growth for our 3 geographic segments. Sales in the Americas advanced 10% on both the constant currency and operational basis. Sales in EMEA advanced 5% on a constant currency basis. And sales in our Asia Pacific region advanced 9% on a constant currency basis.

Moving on to performance by global business units. Global sales for Renal Care were $960 million, advancing 2% on a constant currency basis. Performance in the quarter was driven by growth in PD therapies globally with patient volumes advancing approximately 7% year-over-year. Performance was partially offset by lower sales of select in-center HD product, including the bloodlines business exited in early 2019, which negatively impacted sales in the quarter by approximately $12 million.

Sales in Medication Delivery of $775 million grew 19% on a constant currency basis. Strong global growth was supported by solid commercial execution across our infusion systems and IV solutions businesses. During the quarter, we did see approximately $10 million of distributor purchases ahead of the U.S. influenza season. The fourth quarter also marked our first quarter of sales of the Starling SV hemodynamic monitoring system obtained as part of the acquisition of Cheetah Medical, which contributed less than $5 million to sales in the quarter.

Pharmaceutical sales were $580 million, increasing 9% constant currency and 10% operationally. Strong international sales in the quarter benefited from increased demand for our hospital pharmacy compounding services. Additionally, global demand for Baxter's generic injectables portfolio contributed to growth in the quarter. Performance was partially offset by expected lower sales of inhaled anesthesia products and Transderm Scop due to enhanced competition. U.S. sales of cyclophosphamide were $38 million in the quarter.

Moving to Nutrition. Total sales were $233 million, increasing 10% on a constant currency basis, in line with our expectations and supported by new product launches in the U.S. and Europe. Sales in Advanced Surgery were $231 million, increasing 10% on a constant currency basis. Performance in this business was driven by strong commercial execution as well as further benefit from competitive supply disruptions. Sales in our Acute Therapies business were $144 million, representing growth of 7% on a constant currency basis. Performance in this business continues to be driven by increased global demand for Baxter's continuous renal replacement therapies, supported by the continued rollout of our PrisMax platform.

Finally, sales in our other category, which primarily includes our contract manufacturing services, were $116 million, a decline of 3% on a constant currency basis, reflecting a challenging comparison to the prior year period.

Moving through the rest of the P&L. Our adjusted gross margin of 45.7% increased 160 basis points over the prior year, benefiting from strong top line performance, favorable mix as well as positive manufacturing variations. Adjusted SG&A totaled $626 million, increasing 5% on a reported basis. Strong sales performance, along with a focus on optimizing our cost structure, drove expense leverage in the quarter. Adjusted R&D spending in the quarter of $153 million decreased 7% on a reported basis versus the prior year period. We continue to see the benefit from our efforts to enhance our processes and optimize our R&D organization while prioritizing strategic investments in our innovation pipeline. Adjusted operating margin in the quarter was 20%, an increase of 270 basis points versus the prior year and above our previous guidance range of 18.5% to 19%. Net interest expense was $20 million in the fourth quarter, an increase of $9 million compared to the prior year, driven by lower interest income and increased interest expense from higher outstanding debt balances. Adjusted other nonoperating income totaled $16 million in the quarter. That amount excludes a $755 million noncash charge that we recorded in our GAAP result as a result of the transfer of approximately $2.4 billion of our U.S. pension liabilities to an insurance company through an annuitization transaction in October. The adjusted tax rate in the quarter was 16.5%. Within the fourth quarter, we repurchased approximately $200 million or 2.4 million shares of Baxter stock. For the full year, our repurchases totaled approximately $1.3 billion or 16.5 million shares of Baxter stock.

Turning to full year 2019, sales of $11.4 billion increased by 2% on a reported basis, and 5% on both the constant currency and operational basis. On the bottom line, adjusted earnings increased 14% to $3.31 per diluted share. On a full year basis, we generated free cash flow of more than $1.4 billion. While this was below our initial projections, cash flow generation remains a critical priority for Baxter. And as such, we have implemented several actions targeted to improve working capital efficiency. Our focus continues to be on maintaining flexibility for internal and external investments, supporting strategic growth initiatives and returning value to shareholders. In particular, given the current market uncertainty regarding COVID-19, we are incredibly focused on maintaining adequate liquidity to withstand scenarios that might emerge, so we are able to continue to pursue our capital allocation strategies. As of the end of February, we have nearly $3 billion of cash on our balance sheet, which includes over $200 million in borrowings from our European revolver, which we have accessed as a precautionary measure. We've also recently renewed the terms of our U.S. revolving credit facility, which provides us with access to $2 billion in credit. While we have not drawn on this facility to date, we are currently able to do so, if necessary.

Let me conclude my comments by discussing our near-term financial outlook. As stated in today's press release, given the high degree of uncertainty around potential impacts presented by COVID-19, we are not providing full year 2020 guidance at this time. Depending on how the situation unfolds, we hope to be in a position to provide additional guidance details during our first quarter earnings call, currently scheduled for April 30. Specific to the first quarter of 2020, we expect sales growth of 4% to 5% on a reported basis, and growth of 5% to 6% on both a constant currency and operational basis. For 2020, operational sales will be adjusted for the impact of foreign exchange and the acquisition of Seprafilm. And we expect adjusted earnings, excluding special items, of $0.72 to $0.74 per diluted share for the first quarter.

With that, we can now open 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 the call is being recorded and a digital replay will be available on Baxter International's website for 60 days at www.baxter.com.

And our first question comes from Pito Chickering from Deutsche Bank.

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Philip Chickering, Deutsche Bank AG, Research Division - Research Analyst [2]

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First one is on your manufacturing side. You talked about in the script that you guys don't believe in issues with the supplies. Can you sort of go into more detail around where the majority of your raw materials are coming from? Sort of what percent of those are sourced through the guys like China? And sort of why is that sort of not a risk in terms of to be able to offset from, like, other supplier, (inaudible)? And I have a follow-up after that.

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Clare Trachtman, Baxter International Inc. - VP of IR [3]

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Yes. So just to refresh the question because it's a little hard for you -- to hear you, Pito. So I think what you were talking about is just our overall manufacturing, where we're at, where our raw materials are coming from, how confident are we in the supply chain? Is that kind of summarize what you were asking?

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Philip Chickering, Deutsche Bank AG, Research Division - Research Analyst [4]

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Yes. Yes, and I apologize, on a cellphone obviously.

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José E. Almeida, Baxter International Inc. - Chairman, President & CEO [5]

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Okay. And our raw materials come from a variety of places around the globe. Let me -- because your question has a specificity for COVID-19, I'm sure, and our supply chain. So our electronics come, primarily, from parts of Europe and China. We're working very diligently and we're getting -- starting to get components out of China. We have good safety stocks. We feel comfortable that towards late spring, we will have enough. For most of our products, we have guaranteed ability of having products sold across the globe. So I'm not that concerned. If things become really difficult in China back to what it was in January, February, then the conversation is different. But today, the way we're seeing the shipping lines are clearing up, we're getting products into our factories, not -- don't feel they were under tremendous amount of pressure.

Now when it comes to IV bags. IV bags, the products are made -- for the U.S., are exclusively made in the U.S. Meaning the raw materials are made in our plant in Arkansas, the bags are made in the Carolinas. And we can also make bags down in Mexico in Cuernavaca. So that is a backup plant that we have set up since Hurricane Maria, and we can get -- we are getting products from there now. We can get products -- more products in the future. So our supply chain is we have about probably 20, 25 components in raw materials that we're watching very closely. But we have 24 hours coverage around the globe. Our procurement departments are set in many parts of the world. So at this moment, we feel that between APIs, which are also made in India and China, we have a pretty good grip and the APIs are about the same of the electronics. We're talking about late spring, if things get worse in China, that's a different conversation. But with what we know right now, we are comfortable with inventory levels and we can supply the demand.

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Philip Chickering, Deutsche Bank AG, Research Division - Research Analyst [6]

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Great. And then the follow-up question is going to be a non-COVID-19. Can you walk us through the manufacturing capabilities of THERANOVA at this point? How fast can that be expanded, and whether it's new lines on the manufacturing sites? And how much would each of those cost? And how many of units would those create?

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José E. Almeida, Baxter International Inc. - Chairman, President & CEO [7]

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So Pito, we have the ability today to make turnover, okay? We can make high single-digit millions of -- mid-single digits in the millions of that, okay? We are starting in October converting production lines from our current Revaclear to THERANOVA, meaning the lines will be able to make either one of them. And I think by the time we finished the conversion for the globe, we're going to be able to supply probably close to 30 million units -- 28 million to 30 million units, okay? This is, as we know today, we can always make investment plans for more capacity. As you know or you may not know, we manufacture our own equipment, our spinnerets, our spindles and spinning equipment, and how we bundle the fibers in this very proprietary, great product that we currently design and are making outside of the U.S. today. So that's our capacity. And we're prepared, by the way, once the period of 2 years of demonstration of the add-on payment, what's called, (inaudible) got corrected in Washington last week by somebody. CMS is not tipping this, it's (inaudible) if we can accelerate investment then we can produce more than 30 million, if need-be.

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Operator [8]

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Robbie Marcus with JPMorgan.

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Robert Justin Marcus, JP Morgan Chase & Co, Research Division - Analyst [9]

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So I imagine everyone is very curious about what life will be like under COVID-19. You pulled guidance, but we are almost completely through the first quarter here. So I was wondering if you could comment on trends you're seeing in first quarter in terms of different positives or negatives in the business and any actions you're seeing from the hospitals in Europe and U.S. as they prepare for what's to come here over the next few weeks.

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José E. Almeida, Baxter International Inc. - Chairman, President & CEO [10]

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Robbie, we will -- let me get part of your question. And Jay is also here, he can chime in. We are seeing buying patterns that you see usually in -- with this kind of situation. We have only to compare in heavy flu seasons, and some of us remember, back in 2003, SARS, okay? So we have buying patterns that go from people not understanding what's happening, all of a sudden, stockpiling going on everywhere, okay? So Baxter is at the front line of treating patients with acute respiratory and acute generalized infection, with our CRRT continuous renal replacement therapy, our fluids, our antibiotics, our pumps. So we feel that right now, we are seeing buying patterns that are starting to get more coherent with an outbreak of something like the COVID-19 that we saw probably halfway through the first quarter because halfway through the first quarter, China was more in focus in -- what we saw in China -- and remember, not only we're in the front lines for treatment of diseases such as this but also, we are in the chronic treatment business, which we need to deliver products to people's homes. So we saw in China an acceleration of purchasing for PD compared to new dialysis products. And then what we've seen in the U.S. probably is going to go through the same thing. We're getting cost from state government, not only the Feds, but also the state government. Countries asking placing orders for stockpile of products. So we're starting to see the volume of those orders picking up. We're very -- we've been very judicious because we don't have, at this moment, a capacity restriction, but capacity is all relative, if you go ahead and start buying significant amounts by unit, by hospitals, more than what we can make, we will not be able to supply our business. So we think we're well-equipped to supply the world with the products that we need and of the products we have. And we are not -- we have a few products that may go in allocation just as protection. But we have today the major IV business, IV solutions, we don't have any allocations of that. We are prepared to supply the market and naturally activate our backup plans that we have put in place since Maria.

In terms of the quarter, we're giving guidance a few weeks before we close the quarter. So as I said, we saw 50 patterns in the first quarter. And I think it shows the resilience of our business through a process like this because we do have products used in all sorts of different products -- different settings from the home to the acute side to the more long-term care as well as for nonelective and elective procedures.

Jay, anything?

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James K. Saccaro, Baxter International Inc. - Executive VP & CFO [11]

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No. Joe, I think that's a great commentary. And you described the resilience and the durability of the portfolio. We have a number of product lines, which benefit in this kind of a scenario like acute IV, some of the antibiotics, as Joe described. And then we're watching very carefully our anesthesia and Advanced Surgery businesses, which are more related to actual operating procedures that take place in hospitals. So that's one area that we're watching very carefully. But generally speaking, this is a very durable portfolio that we have.

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Robert Justin Marcus, JP Morgan Chase & Co, Research Division - Analyst [12]

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Great. And maybe just one follow-up. People are starting to worry about the impact to capital equipment sales. So with you set to launch a new pump system, which could actually be in high demand, do you expect any impact to that or to your PD cyclers over the next few weeks and months?

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José E. Almeida, Baxter International Inc. - Chairman, President & CEO [13]

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Very different dynamics, Robbie. Very different dynamics. First of all, at hospitals today in the U.S., the priority is to treat potential patients coming in. I don't think we'll change dramatically their buying patterns for capital in the midterm. But in the short term, it may alter their priorities. Not that we're not going to be able to sell the pumps, we probably will sell them and we'll probably supply product to customers, who today are impacted by the Class 1 recall of our competitor. But that may change a little bit of sequence looking at the priorities that we are currently putting into place. Remember, we're sending service personnel to hospitals, but I don't think we're going to be sending a bunch of people to install pumps now into hospitals. So it may shift a couple of months here and there, but I don't think the pattern of capital by -- as we know today, will change in the midterm to the long term. It will change in the short-term because the priorities of the hospital are to treat the patients. On PD, it's a different conversation. PD is actually the safe place to be, which is the home. Imagine putting patients in a clinic with 5, 7 other very ill patients with diabetes, sometimes insufficiency and with the kidneys not functioning, and going to a clinic in this type of outbreak, it is really dreadful. So I would say that there's a great compelling reason for the peritoneal dialysis modality to take shape and be something strong going forward. I'm not saying right now, but I think this actually reinforces the AAKHI prerogative that the government had on having people treated at home, this is another added benefit of the home treatment.

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Operator [14]

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Bob Hopkins of Bank of America.

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Robert Adam Hopkins, BofA Merrill Lynch, Research Division - MD of Equity Research [15]

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Two quick questions. So it sounds like from your commentary that you've got some products where you're seeing increased demand, like you do in a heavy flu season. In some products, you're seeing a decrease in demand currently. I'm just curious kind of directionally from where you sit today, does this overall feel like a net neutral to your business as far as you can tell right now?

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

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It's tough to say, Bob. That's the reason why we are not putting long-term 2020 guidance out there because we need to figure this thing up. As I said, the buying patterns are really strange. We're getting orders for our CRT equipment. They are in excess of anything we've ever seen, okay? We also have a pretty healthy Advanced Surgery business. So we don't understand some of the patterns today. I have to imagine with the changes in procedures in hospitals, some of our business will be impacted like anesthesia, for instance, you have less procedures than surgery. And on the other hand, we have significant amount of business in the ICU. So I cannot give you an answer precisely what -- if this is a net neutral or not. We're going to have to wait. We hope by April -- end of April when we announced our first quarter results, we have either guidance for the rest of the year or have a better understanding of what's happening at the moment.

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Robert Adam Hopkins, BofA Merrill Lynch, Research Division - MD of Equity Research [17]

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Okay. And then one quick follow-up. I'm really curious as to what you're seeing in China in the Advanced Surgery business. Are you seeing kind of a return to sort of stabilization in procedures in China at this point? Just kind of curious what you're seeing there in that business in particular.

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James K. Saccaro, Baxter International Inc. - Executive VP & CFO [18]

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That's a very small business for us. So I think on an annual basis, we're talking single-digit millions. So it's very difficult for us to comment on procedure volumes in China, given the small size of that business. The largest business in China for us is our renal business, which is a different kind of business and really not an illustration of what's happening in hospitals.

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Robert Adam Hopkins, BofA Merrill Lynch, Research Division - MD of Equity Research [19]

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Okay. I was just trying to get a sense for trends in hospitals in China as they hopefully come out the other side of this.

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José E. Almeida, Baxter International Inc. - Chairman, President & CEO [20]

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Yes.

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Operator [21]

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

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David Ryan Lewis, Morgan Stanley, Research Division - MD [22]

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Maybe, Jay, a couple of quick ones for you. We didn't get segment guidance for the first quarter, so I just wonder if you could help us. If COVID has been largely limited impact, it sounds more neutral impact so far for the first quarter. Can you just bridge us from the first quarter guidance, 5% to 6%? Obviously, the fourth quarter very, very strong. First quarter is anniversarying an easier comp. So just headwinds and tailwinds we should be thinking about to sort of -- to think about the fundamental momentum deceleration in the first quarter? What businesses are stronger, what businesses are weaker? Or what dynamics changed for first? Just so we can kind of get the bridge, that'd be super helpful. Then one follow-up.

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James K. Saccaro, Baxter International Inc. - Executive VP & CFO [23]

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Sure. Overall, looking at the fourth quarter, as we've said in the past, and David, you and I have discussed, we were very pleased with the performance across the portfolio. We saw strength in every one of our geographic regions. We also saw strength across the business portfolio in terms of great Medication Delivery sales, great sales in each of the portfolio. So very strong quarter. There were a couple of onetime components in place in the fourth quarter. So we did see some buy-in from distributors related to our flu business. We did have some benefit on our Advanced Surgery business relative to competitors being off the market, roughly $15 million. There were some accounting adjustment true-ups at the end of the year, perhaps around $10 million or so. So we don't see a markedly different trend going from Q4 to Q1. And we will see -- like I said, given the strength of the Medication Delivery, that business will come down a little bit, but we still expect to have a solid first quarter in that area. So no markedly different trends. And frankly, if you think about our aspirations that we've talked about over the long term, this Q1 guide is very consistent with what we've seen and shared in the past. So like I said, there were a couple of specific items that -- because we're not a 9% growth company at this stage, so there's a couple of specific items that accentuated the great performance in Q4 that we don't expect to repeat in Q1. And really, that's the primary driver. No real change in fundamentals.

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David Ryan Lewis, Morgan Stanley, Research Division - MD [24]

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Okay. And then, Jay, just a related question, both for the first quarter and for the year. So EPS guidance for the first quarter, could you just give us the headwinds and tailwinds, first quarter '19 to first quarter '20, just given the guidance is relatively flattish? And then for 2020, there may be some revenue impact for 2020, positive or negative. Can you just help us understand if there is a negative impact, how we should be thinking about the drop-through or the kind of spending activities that are going on inside Baxter now to support customers?

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James K. Saccaro, Baxter International Inc. - Executive VP & CFO [25]

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Sure. As it relates to Q1 year-over-year, you're right, as we look at our Q1 of 2019, we had $0.75 roughly in earnings per share, and our current guidance is $0.72 to $0.74. The primary driver is really not related to operational performance. I would say the #1 driver year-over-year is tax rate difference. Last year, we had a very large FAS 123R benefit in the first quarter of the year. We also recorded certain other income in the first quarter, which you can see in our restated financial tables. If we were to adjust for those items, I think it's roughly a $0.06 impact. So what you would see is the sales growth, along with some slight operating margin improvement in the first quarter dropping through, and that's really what drives the performance improvement, offset by some of those financial items that I just referenced.

As we look to the balance of the year, our #1 priority as an organization is to fulfill the mission of the company: saving and sustaining lives. And that means getting product to our customers consistently and reliably. What we're seeing is there are situations where there are some extra costs required from a supply chain standpoint to ensure the continuity of supply, to ensure we're getting critical raw materials out of impacted geographies, and we will spend to support that. So I would expect that. We had some very disciplined targets on supply chain spending. But there will be some spending related to supporting our customers and ensuring consistency of supply. We've got a lot of work that's ongoing in terms of enhancing cash flow, but we will also be really thoughtful about carrying extra inventory in the coming months. Because at the end of the day, we have to have sufficient supply, we have to do everything we can to ensure that. And so we will have -- we will carry some extra inventory of critical products and products we think are likely to be stockpiled in the event of a broader scale pandemic. So Dave, as you can imagine, there are a lot of moving pieces as we look at the coronavirus in different manifestations that this can take, and so we are prioritizing serving our customers over just about everything else, but we're also focused on ensuring the safety of our employees. So those are a few comments.

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Operator [26]

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Matt Taylor from UBS.

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Matthew Charles Taylor, UBS Investment Bank, Research Division - Equity Research Analyst of Medical Supplies & Devices [27]

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So I just wanted to clarify two things on your comments on inventory and supplying customers currently. Are you starting to run towards higher inventory levels? It didn't seem like it from your commentary. And then in terms of people stockpiling, are you starting to ration any product? Or how are you managing your inventory to make sure that you're going to have enough if this does get much worse?

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James K. Saccaro, Baxter International Inc. - Executive VP & CFO [28]

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So I'll take the inventory question and Joe can take the question regarding customer stockpiles. On inventory, we are looking to build inventory levels of critical products wherever possible. Now in some cases, that's not possible because we are running full tilt today. But in cases where we do have the opportunity to think, first of all, creatively about where we locate our inventory around the globe but also, are we running the facilities that could support inventory builds at their highest levels? Matt, we have to be prepared for disruption. We have to be. And so the best way that we know to do that is to build up some extra inventory, so that to the extent that disruptions do occur, we are prepared and ready. So that's really our philosophy. You'll see it when we talk about Q1 cash flow, but that's something that we're watching very carefully, and we're absolutely willing to do and carry in the short-term until this situation corrects itself.

Joe, you want to talk about customer stockpile?

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

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Sure. Sure. Matt, we limit hoarding of inventory. Because otherwise you're going to have hospital systems in the U.S. going out and buying more antibiotic, more this, more that. And we are -- we have a control tower approach, where we look at everybody's consumptions and we will supply everyone with their needs. What we want to prevent is people buying months of inventory at a time. They don't even have a place to store. These are bulky items. So we prefer to do our inventory ourselves. We store things ourselves. Our operations today -- Bob Reed runs our operations and supply chain for the company, and is being very thoughtful about how we -- where we put the products. We are starting production lines at a backup. For instance, we started production line in Mexico for the U.S., that is going to be producing millions of bags for the U.S. We have other things that we are doing, just in case. But remember, we want to make sure that everybody gets what they need, and not 1 customer or 2 customers who put in order first. So we're triaging things. We're making sure that our U.S. system, through Heather Knight, is doing a great job in making sure everybody gets what they need. So we're not rationing. We're not allocating everything. What we're doing is just simply making sure the orders are rational and we'll be able to ship them correctly where people need.

The same thing with PrisMax. For instance, the Prismaflex, our CRT machines, you have countries putting orders for hundreds of those, "Well, hang on a minute. Why do you need hundreds? You have less beds than another country." So we're making sure that we made and sold more CRT machines than we ever did in a period of time, but we need to make sure that we can make them, their component lead times, their components were -- we're making sure that we get the supply chain coming in right. The supply chain comes from China and other places, we're making sure that we're doing things right. So we're here to serve our customer. Our mission is so important to us. It's sometimes tough to comprehend looking from the outside, from finance community, how much our employees are committed to our mission. And we'll do everything we can to make sure everyone has what they need.

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Matthew Charles Taylor, UBS Investment Bank, Research Division - Equity Research Analyst of Medical Supplies & Devices [30]

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Maybe I can just ask one follow-up. And I appreciate all the comments on mission, it is very important. The European situation is very fluid, you commented a little bit on China and how that's returned to normal, so that's encouraging. Was wondering if you could give us any color about what's going on, on the ground in your businesses in Italy or other places, where we're seeing infections rise and what that might mean for the U.S.?

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

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First of all, we cannot take China situation for granted because a lot of that has to do with isolation. I think there are papers out there. There was a paper that I read yesterday from the Imperial College in London, talking about that communicable nature of the disease can spread again. So we are not taking anything for granted. We're very cautious. Our daily calls with our locations always stress the safety of our employees first and servicing the patients as well. So when it comes to Italy, we have special letters that we give to employees because we make products in Italy, primarily in Lombardy area. We have 3 plants there, and we're making fluids and we're making equipment there, and we're making sure the plants have -- are staffed properly. And so far, we've not -- have had much disruption to those plants, and the crossing of the border for supplies are -- is happening. So, so far, so good. And Italy is really the hotspot at the moment as well as Spain. We have a factory in Spain, primarily supplying the Spanish market and some of the south of Europe market. We also have plants in England. All of these plants are operating, as we say, with a sense a normalcy, which is kind of not normalcy because everybody has very heightened attention to everything. And this is just to tell you how committed our people are because they live in their homes and going to work every day in plants in North Carolina, in Alabama, in England, in Australia, everywhere in the world, China, 5 plants in China, they all are operating with the normalcy that you would expect under significant stress on the -- by the outside world and by the news channels and everything that's happening around them.

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Operator [32]

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Danielle Antalffy with SVB Leerink.

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Danielle Joy Antalffy, SVB Leerink LLC, Research Division - MD of Medical Supplies & Devices and Senior Analyst [33]

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I hope everyone is staying healthy during these crazy times and safe. Just a quick question, a non-COVID-19 related question. On the Medication Delivery business, very strong operational sales growth in Q4. Obviously, that's not likely to continue. But can you help us understand how sustainable any momentum that you have in the Medication Delivery business is into 2020 and beyond, and the different drivers of the strong growth that we've been seeing there in the back half of the year?

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José E. Almeida, Baxter International Inc. - Chairman, President & CEO [34]

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Danielle, just a bit of color on the business. And Jay, if you want to chime in, please do.

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James K. Saccaro, Baxter International Inc. - Executive VP & CFO [35]

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Sure.

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José E. Almeida, Baxter International Inc. - Chairman, President & CEO [36]

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We are -- what we have done is transformed the U.S. sales and marketing organization. We have done a very good job in selling pumps and placing pumps last year was a crescendo. This is not something that you start and get done in one quarter. The fourth quarter was the result of months and months of preparation of accounts, of bids that we won. This was not an easy, easy path. So I would say that the pumps the way they work, they perform in the fourth quarter, they did very well. We are going down the same path and trying to get the same business in 2020. Because we think we have a pump platform currently in place and, hopefully, when approved by the FDA, which we don't have a date yet, our new pump platform, we're going to be able to perform as well or even better with the new platform because we'll have a more complete set of products that we currently don't have.

We also had good fluid sales. Remember, little anticipation of fourth quarter, not much but some anticipation of the flu season, at that time was not known to the world that the coronavirus was this dangerous. So I will say that this business has tremendous resilience and aided by a new platform and a good, good solid pump, which is our version 9 of our SIGMA SPECTRUM on the market today, we feel comfortable with the trajectory going forward. Is that going to be easy? No, it's not going to be easy. But I think with the contracts that we have signed, which are more long-term contracts, and with the pumps and sets that we have, I think we can continue to aim to perform well.

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James K. Saccaro, Baxter International Inc. - Executive VP & CFO [37]

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Yes. And Danielle, just to add to that, well, what appreciated about 2019 was that there were some unique set of circumstances that allowed us to guide to 6% growth. And part of that had to do with an easy confidence of challenges in the prior year, and then there were some other factors in play. So we were so thrilled, you can imagine, when we actually exceeded the 6% and delivered 7% growth on a full year basis, and it's really a testament to the teamwork that Joe described earlier. Having said all of that, we don't -- we've always said that 2019 was a bit of an anomaly and we will see a lowering of the growth rate a little bit more in line with what the long-term expectations are for this business. But by no means, are we not incredibly excited, because we are. But again, we have to appreciate the specific and unique circumstances that allow that 7% growth to occur in 2019.

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Danielle Joy Antalffy, SVB Leerink LLC, Research Division - MD of Medical Supplies & Devices and Senior Analyst [38]

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Okay. And then I just have one quick follow-up as it relates to the generic injectables business. And how dependent is the growth on that business on upcoming new product launches? I ask the question just because it feels like there's potential for things to even slow down at the FDA. And I'm just curious as to whether the growth in that business is highly dependent upon products to come? Or do you feel like you have the portfolio right now to sustain growth there, which has been very strong.

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José E. Almeida, Baxter International Inc. - Chairman, President & CEO [39]

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So just a curious comment on the FDA, I expect the FDA will slow down the approval process because people are now working there -- mostly are working remotely. But interesting, we just got the other day, our PrisMax 2 approval just came in and came in a couple of months ahead of time. So we made some changes in hardware, improved and some software change that enable an upcoming digital portfolio with WiFi capable and other things, the true view analytic that is going to be on the machine, so we filed for the 510(k), got approval. So we were kind of surprised, it came so fast. Perhaps that was already in the pipeline and got accelerated. But I think we -- I just got news the other day, we just filed for another molecule ahead of time with the FDA. So we can't control and speak on behalf of the FDA. The only thing I can say is that we expect and we should plan for those delays. And we'll keep you posted as we see things, as we're going to know much more, probably in a month from now when we're talking to you, about April, what is going to happen with all this -- with the environment, with the landscape of hospital purchasing patterns as well as agents approvals and things like that. But just a curious fact about one file that was sent in ahead of time, and the other one was approved way ahead of time. So some stuff to predict what's coming.

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Operator [40]

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Larry Keusch with Raymond James.

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Lawrence Soren Keusch, Raymond James & Associates, Inc., Research Division - MD [41]

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Jay, you in your prepared comments, I believe, talked about the cash situation of the company, the drawdown on the European revolver, comments around the U.S. revolver. Could you talk a little bit about how you are thinking about capital allocation priorities as we think about what the stock has done, what asset valuations may be doing out there in the market? So just give us some thoughts around that as you raised, obviously, quite a bit of cash to be ready?

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James K. Saccaro, Baxter International Inc. - Executive VP & CFO [42]

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Yes. Thanks, Larry. We have to be prepared for whatever we can anticipate the coronavirus will -- how that will emerge. And so as a result of that, we've been really thoughtful about having adequate capital on hand. This is the time to have the balance sheet work on our behalf, and we want to be absolutely ready to support the company. And so what we did in the first quarter is we have $200 million plus in borrowings on our European revolver, and that's a facility we use from time to time. But we've chosen to leave that $200 million -- we have cash to offset the borrowing and we have nearly $3 billion in cash. We also recently successfully redid our U.S. revolver, which has a $200 million same-day withdraw feature on it, and some other contemporary provisions that make it a best-in-class facility. And so we have all of that in place. What we wanted to ensure is that there would be no disruptions to our operations. So our primary objective is to ensure we have adequate liquidity on hand, despite the fact that we have a resilient and durable portfolio. We just -- we want to be ready for all circumstances that might emerge. But then, there are opportunities that could emerge as a result of this. And so we are seeing asset prices come down quite substantially in MedTech. And we've seen the share price of that should come down quite a lot. So as we think about allocation of capital and capital deployment and we also want to be ready to take advantage of those kinds of opportunities, we were pleased to close the transaction in the quarter. The Seprafilm film deal was a great one, but we do expect perhaps some of the patients that we've had over the last several years with respect to capital deployment. Let's see how that fares us in the current market environment because, as I said, we are seeing asset prices moderate down quite a bit relative to prior levels.

Joe, do you want to add anything to that?

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José E. Almeida, Baxter International Inc. - Chairman, President & CEO [43]

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Yes. First of all, our first responsibility is to ensure that we have liquidity in the company and we have plenty of that as -- and we are prepared for anything come our way. But also, I think, it's worth noting that we kind of took a long, long pause on speaking about large acquisitions or midsized acquisitions. We could not justify prices. The PEs were so high. And I think sometimes time is on the side of the patient individual. And we are patient here. And I think perhaps having a good amount of money in the bank. And asset values are being down, I think, maybe as an opportunity for us to continue to look at the M&A landscape, but I don't discount the fact that also our stock is -- the pricing is pretty attractive.

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Clare Trachtman, Baxter International Inc. - VP of IR [44]

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Catherine, we have time for one more question.

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Operator [45]

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Our last question comes from Vijay Kumar with Evercore.

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Vijay Muniyappa Kumar, Evercore ISI Institutional Equities, Research Division - MD [46]

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Quick, maybe a guidance question, Jay. Margins for Q1, I think I heard you say a slight expansion, maybe. Is this some incremental investments going on for Q1 and free cash conversion, looking at the restated numbers, it's in the 80s. Is that the new norm? Or should we expect that free cash conversion to step back to 90s?

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James K. Saccaro, Baxter International Inc. - Executive VP & CFO [47]

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So Vijay, there is some impact in terms of investment in the first quarter related to supply chain and other activities. But this is a very fluid situation, and we're watching it very carefully. And like I say, while we are incredibly rigorous on spending across a number of areas, we have to spend to support getting supply to our patients that need it, and our customers that need it, and so we will continue to do that. So this is -- stay tuned on this. We'll have some more commentary when we report Q1 results.

As it relates to free cash flow conversion, if you look at our 2019 result, it was off our expectations. And really, there were a few factors in play. One is, we had a higher receivables balance, and there were 2 drivers of that. One is a different business mix than we expected, so we had a little bit more ex U.S. sales, in sales and higher DSO geographies, leading to a higher DSO. And then second, we had an incredibly strong December. And the result of that is those sales were not paid off with account receivable collections. Those account receivable collections occur in 2020. In addition to that, while we saw improvements in days inventory on hand, we were off a little bit our expectations. Our days payable, we did not make enough progress in this particular area. And finally, there were some higher cash tax payments than we originally budgeted for. Those are the drivers that led to our 2019 free cash flow performance. What I can tell you is our organization is incredibly focused on enhancing cash flow performance. And the number that you cited is not the new normal. We brought in a new Chief Procurement Officer, who is looking across the entire vendor base and restructuring terms and days payable terms across the vendor base. Our supply chain forecasting process started to pay dividends at the end of last year. And as we move to this year, it will pay significant dividends. So we are very optimistic about improvements in free cash flow performance and working capital balance performance, but I do have to take you back to my comments earlier on, which is over the next several months, we are not focused on that so much as we are supplying consistently our patients and if that requires incremental inventory, which it will, we will carry incremental inventory. So we will have this factor that comes into play over the next couple of quarters. But it's going to mask the tremendous progress that we're going to make across the board on free cash flow performance.

So with that, I think we can conclude the call. But Vijay, thanks very much for the question, we appreciate it and the support.

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José E. Almeida, Baxter International Inc. - Chairman, President & CEO [48]

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Thank you all and be safe. Be protective of your health, and we wish you all well. Thank you.

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Operator [49]

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Ladies and gentlemen, this concludes today's conference call with Baxter International. Thank you for participating. You may now disconnect. Everyone, have a great day.