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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good morning, ladies and gentlemen and welcome to Baxter International's Fourth Quarter 2018 Earnings Conference Call. Your lines will remain in a listen-only mode until the question-and-answer session of today's call. [Operator Instructions] As a reminder, this call is being recorded by Baxter and is copyrighted material. It cannot be recorded or rebroadcast without Baxter's permission. If you have any objections, please disconnect at this time.
I would now like to turn the call over to Ms. Clare Trachtman, Vice President, Investor Relations at Baxter International. Ms. Trachtman, you may begin.
Clare Trachtman
Thanks, Candace. Good morning, and welcome to our fourth quarter 2018 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 2018 financial results along with our financial outlook for 2019. A supplemental presentation to complement this morning's discussion can be accessed on our Web site. This presentation, along with related non-GAAP reconciliations, can also be accessed at Baxter's external Web site in the Investors section under Events & News.
With that, let me start our prepared remarks by reminding everyone that this presentation, including comments regarding our financial outlook, new product development, business development and regulatory matters contain forward-looking statements that involve risks and uncertainties. And, of course, our actual results could differ materially from our current expectations. Please refer to today's press release and our SEC filings for more details concerning factors that could cause results to differ materially.
In addition, on today's call, non-GAAP financial measures will be used to help investors understand Baxter's ongoing business performance. A reconciliation of the non-GAAP financial measures being discussed today to the comparable GAAP financial measures is included in our earnings release issued this morning and available on our Web site.
On the call this morning, we will be discussing operational sales growth which for historical periods adjust for the impact of foreign exchange, generic competition for U.S cyclophosphamide, our acquisition of two surgical products from Mallinckrodt in the first quarter of 2018, and for a full-year 2018 approximately 7 months of sales from the acquisition of Claris in July 2017. 2018 operational sales growth guidance adjust for the impact of foreign exchange and generic competition for U.S cyclophosphamide.
Now I'd like to turn the call over to Joe. Joe?
Good morning and thank you for joining us. We are pleased to share our fourth quarter results with you today and to discuss our expectations for 2019. I will begin with a quick review of our fourth quarter performance before sharing my reflections on the year as a whole. Jay will then provide more detail on the financials, including our 2019 outlook. We will wrap up with Q&A.
Baxter closed the year with a solid fourth quarter, delivering sales growth of 2% on a reported basis, and 5% on both a constant currency and operational basis. A strategic execution with strong operational performance and disciplined financial management resulted in adjusted EPS of $0.78, up 22% year-over-year.
Drivers of growth in the quarter included the company's Renal Care, Pharmaceuticals, Advanced Surgery, and Acute Therapies businesses; increased demand for Baxter's contract manufacturing services also contributed to performance in the quarter. This strength helped offset performance in our Medication Delivery and Nutrition businesses, which was in line with the guidance we shared on our third quarter call.
Growth in Renal Care continues to benefit from increased demand for our peritoneal dialysis products globally. In the U.S., we experienced the highest growth for PD patients of the year with patient volumes increasing high-single digits in the fourth quarter. And in Japan, the successful rollout of Kaguya is also contributing to performance with patient growth advancing mid-single digits in the quarter.
In Pharmaceuticals, growth in the quarter was driven by strength across the portfolio globally, increased sales of premixed injectables, anesthesia, and critical care products as well as a strong performance in our pharmacy compounding business, all contributed to growth. This helped to offset expected lower U.S sales of BREVIBLOC and cyclophosphamide in the quarter.
Advanced Surgery achieved growth of 17% on a constant currency basis in the quarter, including a contribution of approximately $20 million from sales of RECOTHROM which benefit from competitive supply constraints during the quarter.
Performance in acute therapies continued to be driven by improving utilization for CRRT globally as well as increased demand for our multi organ support products. Finally, performance in our U.S Medication Delivery and Nutrition businesses has stabilized, and we are in the process of executing on efforts to return demand for impacted products to pre-hurricane levels. In addition, we are seeing closer alignment between end user unit demand and financial unit purchases for a large volume IV solutions.
As we discussed last quarter, going forward we continue to expect these businesses to grow in line with their respective market growth rates as well as benefit from new product launches. In addition, last quarter I mentioned that we were taking decisive action to renew strategic momentum in our U.S hospital businesses.
To this end, I’m pleased to announce that Heather Knight will join us as the new General Manager for our U.S hospital business effective February 11. I worked with Heather previously, so I know firsthand that she will bring outstanding leadership skills and superior insights on the medical device market.
On our fourth quarter performance illustrates important progress in our long-term strategic journey, Baxter's emphasis on increasing innovation, unwavering financial discipline, and driving operational efficiency, all contributed to our ongoing growth.
For the full-year 2018, Baxter achieved sales growth of 5% on a reported basis, 4% on a constant currency basis, and 3% on an operational basis. Our overall strength was also reflected geographically, where we achieved mid-single digit constant currency sales growth across all three of our geographic reporting segments: Americas, APAC, and EMEA.
Of note, Q4 represented the highest quarterly operational growth of the year for both our APAC and EMEA regions. Our momentum carried over to the bottom line. Our adjusted EPS was $3.05, up 23% year-over-year. And Baxter generated free cash flow of over $1.4 billion in 2018, up 16% versus 2017. Creating value for stockholders is essential to our business model.
In 2018, we increased our quarterly dividend by 19% and returned over $2.4 billion to investors through our share repurchase program. In addition, the research and development and commercial milestones we achieved in 2018 and the early weeks of 2019 demonstrate a promising future of organic growth through innovation.
Earlier this month, we announced that we had enrolled the first patient in our U.S clinical trial for our in-home, on-demand PD solution generation system. Now, a few weeks later, patient treatments are underway. We believe this technology has great potential to improve the patient experience and simplify therapy management.
In 2018, we announced a collaboration with the Mayo Clinic to establish a Renal Care Center of Excellence, serving patients across a continuum of care to drive improved outcomes. This will be an opportunity to put our combined expertise to work in new ways. It also represents a meaningful pathway for pursuing other creative collaborations with the potential to advance patient care and drive business performance.
And 2018 also featured a range of pivotal, differentiated new product launches from across all six of our businesses. Our leading-edge PrisMax, CRRT in organ support technology is now helping treat acute care patients in multiple European markets. As I mentioned earlier, the Kaguya APD cycler with embedded share source technology is quickly being embraced in Japan, and is a compelling in-home therapy option. Our spectrum IQ smart pump platform is now being adopted in the U.S and Canada.
And the Evo IQ pump platform is being launched in other global markets. Additional launches across the U.S and around the world include IV pharmaceuticals, surgical hemostats, and sealants and nutritionals. As 2019 unfolds, we are moving ahead at full speed. We are continuing to address unmet patient and customer needs, building out our pipeline and working with regulatory agencies to successfully launch our products across the globe.
We continue to thoroughly assess opportunities to further our impact to patients and healthcare providers through strategic partnerships and business development. And we remain intently focused on expanding efficiencies across the organization. This all supports our objective to accelerate performance and deliver top quartile results for all stakeholders.
Now I will pass it to Jay, who will walk you through the financials in more detail.
Thanks, Joe and good morning, everyone. As Joe mentioned, our fourth quarter results demonstrate a strong finish to 2018. Throughout the year we delivered consistent bottom line strength through improved operational performance coupled with the ongoing benefit of our business transformation initiatives.
Moving into 2019 and beyond, we continue to be well-positioned to achieve our long-term financial goals. I will start by discussing our fourth quarter and full-year 2018 results, before providing our financial outlook for 2019. Beginning with the fourth quarter, global sales of $2.8 billion increased 2% on a reported basis and 5% on both a constant currency and operational basis. This was favorable to our expectations driven by performance in our Renal Care, Pharmaceuticals, and Advanced Surgery businesses.
On the bottom line, adjusted earnings increased 22% to $0.78 per diluted share. This also exceeded our previous guidance of $0.71 to $0.73 per share, driven primarily by sales performance, disciplined financial management and a modest benefit from increased share repurchase activity, which Joe referenced earlier.
Now I'll walk you through performance by our geographic segments in global business units. Note, for this quarter constant currency sales growth is equal to operational sales growth for all businesses with the exceptions of our Pharmaceuticals and Advanced Surgery businesses and for the Americas region, for which we will provide operational growth in addition to constant currency growth.
Starting first with sales growth for our three geographic segments. Sales in the Americas advanced 4% on a constant currency basis and 3% operationally. Sales in both our EMEA and APAC regions advanced 6% on a constant currency basis.
Moving on to performance by global business units. Global sales for Renal Care were $953 million, advancing 5% on a constant currency basis. As Joe mentioned, performance in the quarter was driven by high single-digit growth for PD therapies globally. Partially offsetting this growth was lower U.S sales of in-center HD, primarily related to lower sales of low margin distributed bloodlines.
Sales in medication delivery of $660 million were flat on a constant currency basis in line with the expectations we communicated last quarter. During the quarter, we continue to work with distributors as they reduce their inventory levels. We believe that destocking is largely complete and distributor purchases will now more closely align with end user demand.
With respect to small volume parenterals, we're on track with our efforts to return demand to pre-hurricane levels, as we continue to reinforce to our customers the safety and efficiency of our SVPs for drug reconstitution. Finally, pump sales came in slightly below expectations.
As discussed last quarter, we are seeing a longer sales cycle for Spectrum IQ, given the two way hospital connectivity with the hospital EMR, as well as customer somewhat delaying purchases of new pumps. Despite these dynamics, we gained just under a point of market share in 2018 and expect to gain a similar amount in 2019.
Pharmaceutical sales were $540 million, increasing 9% constant currency and 11% operationally. Growth in the quarter benefited from strength in our anesthesia and critical care products, driven by increased sales of Transderm Scop and Sevoflurane.
Strong sales of Baxter's injectable premixed drugs also contributed to growth in the quarter benefiting from recent product launches. And finally increased demand for Baxter's Pharmaceutical comp -- pharmacy compounding services also contributed to performance. This growth was partially offset by lower sales of BREVIBLOC and cyclo during the quarter. U.S cyclo and BREVIBLOC sales were $39 million and $14 million, respectively, in the quarter.
Moving to Nutrition, total sales were $215 million, down 5% on a constant currency basis. We continue to focus on driving growth recovery through market education and reinforcement of supply availability. During the quarter, we saw a slight pickup in the market and our efforts to regain demand loss as a result of the hurricane are on track.
Sales in Advanced Surgery were $214 million, increasing 17% constant currency and 5% operationally. Sales of RECOTHROM and PREVELEAK contributed approximately $21 million in the quarter. As Joe mentioned, RECOTHROM fourth quarter sales benefited from a competitor supply constraint. These issues have since been resolved.
Sales in our Acute Therapies business were $137 million, representing growth of 12% on a constant currency basis. Strong performance in the business continues to be driven by increased global demand for Baxter's continuous renal replacement therapies. Finally, sales in our Other category, which primarily includes our contracting manufacturing services were $122 million, an increase of 14% on a constant currency basis. Performance in the quarter was driven by increased demand for our contract manufacturing services.
Moving through the rest of the P&L, our adjusted gross margin of 44.3% decreased 10 basis points over the prior year as the benefit of operational improvements were offset by a certain one-time manufacturing cost in the quarter. Adjusted SG&A totaled $597 million, decreasing 4% on a reported basis and 2% on a constant currency basis, driven by our business transformation initiatives targeted with improving operational efficiency, which helped to offset a loss of approximately $9 million in transition service income received from Shire in 2017.
Adjusted R&D spending in the quarter of $165 million, decreased 9% on a reported basis and 7% on a constant currency basis versus the prior year as we anniversaried certain milestone and third-party payments made in the fourth quarter of 2017. Strategic investment in our innovation pipeline continues to be a priority.
Adjusted operating margin in the quarter were 17.5%, an increase of 210 basis points versus the prior year. Growth was largely driven by operational expansion and continued focus on transforming how we more effectively manage our business.
Net interest expense was $11 million in the fourth quarter and adjusted other income totaled $34 million in the quarter, primarily reflecting a benefit from changes in our U.S pension plan and foreign exchange gains on balance sheet positions. The adjusted tax rate was 18.9% for the quarter and as previously mentioned adjusted earnings of $0.78 per diluted share exceeded our guidance of $0.71 to $0.73 per share.
Within the fourth quarter we repurchased approximately $1.4 billion or 20.9 million shares of Baxter stock, reflecting our stated intention to strategically repurchase shares trading at a discount to our intrinsic value calculation.
Turning to full-year 2018, sales of $11.1 billion increased by 5% on a reported basis, 4% at constant currency and 3% on an operational basis. On the bottom line, adjusted earnings increased 23% to $3.05 per diluted share. On a full-year basis, we generated free cash flow of more than $1.4 billion, marketing an improvement of approximately $200 million or 16% versus the prior year. This is slightly below our guidance of approximately $1.5 billion, primarily due to a higher year ending inventory balance than we expected.
Let me conclude my comments this morning by providing our guidance for the first quarter and full-year 2019. For full-year 2019, we expect flat to 1% reported sales growth globally, 2% to 3% constant currency, and 3% to 4% operational. I would like to point out some key assumptions reflected in our full-year sales outlook, which included approximately 200 basis points of foreign exchange impact, and full-year's U.S cyclophosphamide sales of approximately $95 million versus $166 million in 2018.
Operational sales growth adjust for the impact of foreign exchange and generic competition for U.S cyclophosphamide in 2019. Operational growth includes the impact and were approximately $75 million related to lower U.S sales of BREVIBLOC as well as approximately $55 million of lower U.S in-center HD sales. Collectively, these two factors negatively impact 2019 growth by approximately 130 basis points.
Moving to guidance by business, on a constant currency basis, except for otherwise noted, in Renal Care we expect growth of 2% to 3% reflecting continued momentum in PD partially offset by lower sales of U.S in-center HD, aligned with our stated strategy of enhancing performance by exiting lower margin product lines.
In Medication Delivery, we expect sales to increase approximately 6%. We expect our Pharmaceuticals business to decline 3% to 4% on a constant currency basis. Adjusting for U.S cyclo, operational growth is expected to be flat 2018, reflecting the lower BREVIBLOC sales I just mentioned.
Moving to Clinical Nutrition, we expect sales growth of approximately 3% as we work to return customers in the U.S back to pre-hurricane prescribing patterns. For our Advanced Surgery business, we expect sales to increase 3% to 4% on a constant currency basis. For the Acute Therapies business, we expect growth of approximately 7% to 8%.Finally, in our Other business, we expect sales to decline low single digits as we don't currently anticipate the outperformance in 2018 to repeat in 2019.
Moving down to P&L, we anticipate adjusted operating margin expansion of 60 to 100 basis points. We expect net interest expense of approximately $60 million to $65 million and adjusted other income of approximately $80 million to $85 million for 2019. For the year, we expect an average adjusted tax rate of approximately 18% and a full-year diluted average share count between the range of 515 million to 520 million shares.
Based on these factors, we expect 2019 adjusted earnings excluding special items of $3.22 to $3.30 per diluted share. And finally for the year, we expect to generate operating cash flow of approximately $2.3 billion and free cash flow of approximately $1.6 billion.
Specific to the first quarter of 2019, we expect sales to decline approximately 3% on a reported basis, growth of approximately 1% on a constant currency basis, and growth of 1% to 2% on an operational basis. And we expect adjusted earnings excluding special items of $0.66 to $0.68 per diluted share.
With that, we can now open-up the call for Q&A.
Thank you. [Operator Instructions] And our first question comes from David Lewis of Morgan Stanley. Your line is now open.
Good morning, David.
Hello. This is actually Jon Demchick on for David. Thanks for taking the questions. Would love to kind of dive a little bit into the IV solutions part of the medical device -- the medication delivery business and kind of think about what projections you’re expecting for the first couple of quarters through the year, and how you see the alignment of supply to the financials that you're going to see? Like how much visibility you think is there now today relative to the visibility you saw during 2018?
Good morning, John. We never met, but welcome to our call. I’m going to take the first part of the question and then I will pass on to Jay, who will get into more of the financial impact. Listen, we found now that we're largely the inventory in the chain is largely balanced, meaning that while we see financial results or dollars coming in and the inventory levels at distributors, so sales out to hospitals and inventory is balanced. We saw that throughout Q4, we think that we have a stable market right now, and which made us conclude that we have not lost market share. Our market share is stable and some of the OEM contracts that we had spoken about are coming back a little faster, and we have some opportunities. So what you see in the progression of the quarters is that we have a very tough comp in the first quarter because quite a few remember last year there was a significant amount of buy-in, a tough flu season was the reaction to the hurricane in late 2017. So this is a tough quarter for us to compare, but if you look across the other quarters and for the year, Medication Delivery will be a 6% business, which tells you that this is a well-established business, a stable business. And we have plans to continue to convert that. We have the launch of our new pump coming in. The new pump will drive more stats, will drive more volume and the ability to capture those that will be great. The other thing that makes this quite stable is we are two out of three GPOs signed. In one of them, we are 100% re-signed with the IDNs and we feel very comfortable about our position in the marketplace. Now let me pass on to Jay, who will talk a little bit more of the financial impact.
Yes, just thinking about the IV therapy business, we did have a substantial buy in, in the first quarter of last year. That’s rough -- it was roughly a $15 million positive sales impact in the first quarter. So recognizing this is a low-single digit end user demand that was a -- that was certainly a departure which we’ve discussed in the past. And so as we look at our plans for the U.S business with respect to IV therapy, you will see a decline in the first quarter this year into double-digits. But then as we move to the back half of the year, in the second quarter it’s a more normal quarter, and then in the back half of the year, we do have the benefit of easy comps in large part because -- of some of that inventory coming out of the channel. So really that’s the sequencing that we expect to see during the year.
Okay. And actually guys this is David. I’m stepping in for John. Sorry about that. So two questions for me, Joe, kind of more strategically. And the first one, obviously, is two focus items for investors. The first is fluids, and I think you’ve addressed that for '19 and the first quarter. The second, obviously, is balance sheet deployment, Joe. How urgent are you feeling about deployment in 2019 to sort of get back to 5%. On one hand, I think about the headwinds in your business BREVI and HD, you can almost get back to 5%, just adjusting for those headwinds versus your '19 guidance. But how important is M&A to you this year to deliver your LRP targets in '20? And then for Jay, just thinking about margins, obviously you’ve talked about a margin opportunity of 300 basis points over the next two years guiding to about 50 this year. How good do you feel about the ability to still deliver those margin targets into 2020, just relative to the '19 guide? Thank you.
Good morning, David. That was well, well orchestrated. So we’ve got three questions out of your call. You said only two, but I will -- those are good questions, so we’re going to answer them properly. M&A, listen, we continue very aggressively looking for opportunities, and I want you guys to think about not on the size base but more so on adjacencies and things that’ll make sense for our company for Baxter. It is -- don’t mistake our aggressiveness in looking for targets with our discipline of really understanding the financials behind the returns for acquisitions, which are unchanged. We are looking for molecules. We have and we require molecules in the marketplace to augment our Pharmaceuticals, we're interested in Critical Care, we’re interested in many other areas that are adjacent to our business. Size is not the priority, but the ability to augment that. Will M&A be a great part of our LRP, we augment our LRP. I still -- I’m still very confident that we have the ability to deliver the LRP. We’ve done M&A at the moment because we have $1.7 billion in new products coming in 2023, and that is still in the plans. If you look at our new product development sales contribution in the second half of 2018, it was great. Now we have some really -- a lot of new products coming in, so we’re confident in that, but I think augmented with adjacencies, M&A, and don't be hung up on size. Some may be a little larger than others, but we’re working intensively. But I want our investors to understand -- I would like to underscore the fact that the returns and the financial returns to our shareholders is very, very important to us, so we would not do a deal that is in the fringes or negatively impact our return to our shareholders. I will pass on to Jay on the balance sheet.
Yes, great. Great. Yes, in terms of margin, but also in terms of actual sales growth, I do think it's important, David, you referenced something. Our operational sales growth this year is 3% to 4%. As you know, excludes the impact of cyclo, but it does include two important impacts. One is BREVIBLOC, we discussed this extensively, roughly $75 million. But then, we’ve also talked about this idea of historically exiting lower margin businesses. I mean, one of the items we pursued is kind of shrinking certain areas where there was little margin in our in-center HD business. But that’s roughly a $60 million impact. So thinking exclusively about sales growth, the 3% to 4% includes within it roughly a 130 basis points of impact that depress it in 2019 relative to the normalized rate of growth we will expect to see going forward. The second item, as it relates to margin expansion, this is one area we’ve been incredibly focused on over the last several years. And this year we will see further margin growth, but I will highlight that this year we’re faced with a number. Of very significant headwinds on the path to delivering this margin expansion. Cyclophosphamide, that’s roughly 1% of margin impact. BREVIBLOC, that’s -- sorry, BREVIBLOC is roughly 50 basis points of margin impact, and I should say cyclo is roughly 50 basis points. And then foreign exchange is roughly 30 basis points. So if we put these items together, we’re talking about again a 130 basis points of headwinds that we fight through on the way to the margin expansion that we will deliver. This year we had a number of headwinds as well. We’ve discussed those in the past and we were able to again deliver nice margin expansion in the face of that. So we don’t point to headwinds as a reason to not deliver margin expansion, but again it does depress margin expansion relative to the normal rate of growth.
Great. Thanks so much.
David, any handle off for further questions or should we move on? Right.
No, I will stop there. Thanks, guys.
Thanks. Thank you, David.
Thank you. And the next question comes from Robbie Marcus of JPMorgan. Your line is now open.
Great and congrats on the good quarter. Jay, maybe I can follow-up on that. The guidance came in, I think, pretty good on the top line, especially considering all the headwinds that weren't factored into street models. But first quarter came in a little bit lighter. So maybe you can walk us through the puts and takes of the cadence through 2019 and maybe some of the product launches or different factors that give you confidence in that second half acceleration.
Yes, Robbie, you’re correct. This is a meaningful acceleration that we will see towards the back half of the year in the back three quarters, I should say. And there are a number of specific items impacting the first quarter growth. So we pointed to operational sales growth of 1% to 2%. But included in that, BREVIBLOC, the biggest impact that we’re going to see is, I believe, in the first quarter. Its roughly $35 million in sales, roughly 1.3 percentage points of growth. The IV buy-in, so we did see a very significant heightened buying pattern in the IV business. I referenced it moments ago. That’s about $15 million or roughly 50 basis points of growth. And then in-center HD, this exit that we pursued is another factor that’s depressing Q1 sales growth. That’s roughly $15 million. So again, as we look at this first quarter growth of 1% to 2%, we’ve almost 2.5 points of sales growth headwinds that are most pronounced in the first quarter of the year. Now transitioning that to an EPS discussion, quite simply $0.05 of BREVIBLOC, $0.01 of cyclo, $0.03 of FX and by the way FX is more of a first half phenomenon than a second half phenomenon. You put these items together and its significantly impacting the first quarter EPS. Furthermore, we’ve a number of benefits that start to accrue to the second half of the year. We’ve the easier comps in the U.S Medication Delivery business that I mentioned earlier. And then furthermore, we start to see the benefit of some of the new products and the acceleration there. Joe -- with Joe in his script referenced some of the great progress that we’re making and we’re pleased really across the board, but it's not overnight that these products come to bear, and so we do see a bigger impact in the second half of the year, on the way to an even bigger impact in 2020.
Thanks. That’s really helpful. One other thing I wanted to dive into is, it looks like the pharma business did very well in the quarter, even when backing out the generic headwinds. I think it's a part of the business a lot of people don't understand the underlying drivers. Can you give us a little bit more insight into what’s driving the outperformance there and how to think about the key growth drivers in '19? Thanks.
Robbie, the performance is being driven by several factors. Let me start highlighting the success of the molecules that we’ve been launching internally from Baxter, and those are special molecules, not the molecules themselves, but the delivery of the API. And the second is our premix. So premix is the substitute for when we have shortages. We made great efforts to substitute some of our MINI-BAG Plus product lines in the marketplace by premixes and the premixes are more effective and even safer way of delivering the medication and that is doing extremely well. The growth is fantastic. We are moving up 30% plus of growth in premixes. So I know that we both had Medication Delivery and the recap of and recover of our MINI-BAG plus and MINI-BAGS business. But some of that we actually prefer the conversion into premixes which has been extremely success, but the margins are higher by 20%, 30% and we think that that is the way to go. So our Pharmaceutical business is doing extremely well. We have more molecules coming up in '19 and '20. And we feel that that business is finally taking off, ex this cyclo and BREVIBLOC, which eventually will be something of the past and we can move onto the new Pharmaceutical business which is leadership in generic injectables with novel ways of delivering the medication. Thank you. Thanks, Robbie.
Thank you. And our next question comes from Bob Hopkins of Bank of America. Your line is now open.
Great. Thank you and good morning. Just two questions for me. One is a clarification and I'm sorry if I missed this. But are you guys today explicitly reiterating your 2020 operating margin EPS and rev growth targets that you set last year?
Yes, Bob, yes we are. There is no changes to those guidance numbers.
Okay. And then the other thing I wanted to ask about was just Medication Delivery. We have talked about it a little bit here, but obviously that was a division that cause you trouble for two quarters of 2018. And now your guidance for this year is for 6% growth. I realize some of that is easy comps, but it just seem like a little higher guidance than I anticipated given what happened in 2018. And also given your comments about the tough competitive landscape on the pump side. So maybe you could walk through a little bit what gives you confidence in that 6% from a new product prospective, because even comp adjusted you’re projecting accelerated growth here in 2019.
So we're definitely getting some benefits from the recapture or the acceleration campaigns with respect to MINI-BAG, MINI-BAG Plus, and then some stability in the LVPs. So the reality is because of the rebates that took place in a number of our product lines, we are able to see above market growth rates in certain product categories. As we referenced in the call, we were pleased to see some of the progress that we made in those areas in -- fourth quarter of 2018, so very, very solid early signs of the recapture campaign paying dividend. And that will continue to pay dividends. Again, above market growth barring the first quarter issue. So that's one factor. The second factor that comes into play is we do start to see accelerated performance on the new pump -- the version 9 of our spectrum pump, which starts to accelerate towards the back half of the year. We have been pleased with the reception of this pump in the marketplace, well received by clinicians around the U.S., so very positive reception. But the sales cycle has been longer than we expected. So as a result of that, we will start to pay that all off in 2019. We have got a line of sight to the pipeline that gives us confidence that we will be able to do that. So you put those things together and like I say, this is a -- this is one where we have a high level of confidence in the acceleration that takes place. And then furthermore, we do have some easier comps in the second half of the year for -- certainly as we look at performance there.
Okay. Thank you.
The only other comment I would make there, too, as well is we’re going to see some acceleration outside the U.S as well as we anniversaried some of the comps. As you remember, we took some of that volume to the U.S and now we have successfully -- we are going to successfully bring some of that volume back to those Latin American markets as well.
Thanks very much.
Thank you. And our next question comes from Matt Taylor of UBS. Your line is now open.
Hi. Thanks for taking the question. So the first one I wanted to ask about was the Renal business, that was a little bit of a tick up here and you highlighted now you got all your cyclers is around the world and more people are using them. Can you talk about assumptions for 2019 in terms of any pickup that you could see in PD because of the cyclers? And then, I would love to get a little bit more color on how you're feeling about on-demand PD looking into 2020 and what kind of impact that can have?
I will take that. Our Renal Care, 2% to 3% is our guidance in 2019. And I just want to give a little bit color why is 2% to 3% and how do we connect the PD patient growth to it. We consciously are walking away from business that were unprofitable in some geographies, primarily bloodlines and was a large volume of product. So our HD business is artificially depressed because our decision -- we were making no money. As a matter of fact, we are losing money in that business and it was a good thing that we are not going to be in that business anymore. Moving to the PD business, we are still looking between 5% to 6% in patient growth. This is a very healthy business. The best geographies in the world right now are North America as well as parts of Asia, Japan and China. We have very successful launch of CLARIA with SHARESOURCE, relaunched in parts of Europe, very difficult time we had with the privacy issues in Europe and now we overcame that issue in many geographies in Europe, and we’re trying to see CLARIA with Sharesource, which is a different cycler. Similar to the HomeChoice here, the old HomeChoice in U.S., but updated with software for monitoring. So that is now been using several different countries in Europe. We struggled in the beginning with the privacy. We got to understand how difficult it is to operate in Europe with software [indiscernible], there's home monitoring, but now that's going well. I will point to Japan, Japan the Kaguya business in Japan is doing extremely well. We already have a 1,000 patients on therapy there. We expect to really accelerate that business in '19 and '20. So expect 5% to 6% patient growth. Very healthy business in the U.S. Our partnership with DaVita is going well, great partner and great customer.
Great. Thank you. And any additional color you can talk about in terms of the pipeline with on-demand PD?
Well, we just have few patients lined up to start receiving the therapy. We have one that is started and he is going well so far. Early to say, but it is something -- this is a very classic Baxter stance. And I would say something we do something. We tend not to say stuff and not do it. So we put our patient on therapy like we promised. We are going to work hard on that therapy. It's complex, because you're making the drug in people's homes, but it's going well so far. And I tell you we are going to have several iterations of this technology going forward, because this is going to be almost a comparison to what the electric car was seven, eight years ago. You start and you started evolving and evolving, and we’re going to evolve this technology. We will continue to be the leaders in home therapy for peritoneal dialysis.
Great. Thank you. And can I just ask one follow-up on the pharma business? You mentioned some of the dynamics before, but I was hoping you could be more specific about kind of the both number of molecules you're launching in '19 versus '20, really thinking about the Claris dynamic there. I mean, should we see some acceleration in terms of the molecules in the growth in '20?
Well, let me -- let's divide this in pieces. We have Claris molecules, which were part of our plan for Claris. And as you know we have the warning letter for the facility, we are doing everything that we are -- we promise to do to the FDA. We will be inspected a couple of times before we can get clearance or VAI for that location. So our focus right now for Claris is to be able to get that facility cleared of the warning letter, and all the efforts that we promised the agency are being done. We also have contingency plan for that plant, because we would like to have Plan B and our Plan B is for most of our products that will be sold in the U.S., we would have CMOs or backups so we can continue operation if something doesn't work. It means that we are working everything that -- every angle that we can to make sure there is no disruption to our plan because the warning letter at Claris. So this is -- this addresses Claris. The other molecules that we have, we have some important molecules launched at the end of '19 and '20, they’re really breakthrough molecules. Not that the molecule itself is breakthrough, but the delivery system of the molecule is a premix and nobody has that in the market. I'm not going to give the name of the molecule, but I'm telling you we have some really interesting stuff going on. The other thing is we have molecules that are launched last year, we have few more launched in this year. The one is a launch last year, I have to say one of them, and I'm not going to give the name of the molecule, is done extremely well with 40% higher sales in our estimates for last year. So that will continue to do well. So our plan for Pharmaceutical is absolutely offset and leaving the past cyclophosphamide and BREVIBLOC and things that were the chief products for the company few years ago were moving into, as we said, we are going to add almost 70 molecules to our portfolio and above double that the ways to deliver those molecules and we are going to do this in a multitude of regions like we promised last year and we are on plan to do it. As I said, we have an important molecule, that hopefully will be launched by the end of '19 and we will announce that properly when that happens.
Great. Thank you, Joe.
Thank you.
Thank you. And the next question comes from Vijay Kumar of Evercore ISI. Your line is now open.
Hey guys, thanks for taking my question. So couple of, I guess, guidance, housekeeping questions here. Is the guidance assuming any contribution or I guess I should say contribution, the resolution of FDA a warning letter of Claris. And I'm curious, Jay, you mentioned the LATAM business coming back for IV fluids, that happens to be a tender business. I'm just curious have you signed any tenders? Do you have any visibility?
So from an FDA standpoint, there is no resolution assumed in our 2019 numbers for resolution of the Claris warning letter. Obviously, that becomes an important component of our 2020 numbers. So to the extent that we get that resolved along the time frame we expect, then the long range plan that we have are intact with no change. We are looking for mitigation tactics in the event that, that does not occur. But as we look at 2020, that will be an important component for us to get resolved. As it relates to Latin America, yes, certainly there is a different dynamic in terms of tendering in Latin America versus certain other markets. And so, we have moved some volumes back to Latin America. We have clear line of sight to sales performance and where that's going to go. In some cases tenders have been one, but as opposed to going through that in a lot of detail, what I will tell you is we have a high level or a solid level of confidence in our ability to deliver some of the IV sales in the Latin America business.
That's helpful, Jay. Just one follow-up on -- the interest expense guidance. It looks like interest expense is going up. Is there any -- I'm just curious, what is the implication for cash balance or capital deployment just because this is ticking up?
Yes, we have a -- we do have a higher interest expense year-over-year, so that's a few cents of impact. And there is really two factors in play. One is the rising interest-rate environment. But more than that, we have repurchased a significant number of shares. As we said in the past, we have opportunities to buy shares in the market and it's below the intrinsic value, we take advantage of that. In the fourth quarter, we did see a dislocation. We saw fairly meaningful moment in the stock price, but our long-term valuation of the shares was very much intact. We took the opportunity to produce a number of vehicles to repurchased shares. That has a share benefit in terms of share count for the full-year 2019. There is an offset to that, which is increased interest expense. Now as we look at the overall position for Baxter, the net debt situation, we are still significantly below one turn of net debt to EBITDA. And while we’ve said our long-term target is 2X net debt to EBITDA, what I will tell you is I believe we have more -- our main goal is to maintain a solid investment grade credit rating and I do believe we have more flexibility than that as we look at further capital deployment. So it doesn’t -- the share repo that we pursued in the fourth quarter really does not impact our business development or capital deployment strategy to any significant extent going forward, but it's a fair point about increased interest expense.
I just want to, Vijay and folks to underscore what Jay just said, we have said that we were not going to let cash sit in the balance sheet unused. So we are going to return that to the shareholders in a way that we can make the most out of it. So ideally we like to buy more companies and spend money in M&A, but if we don't find the target with the right return, we are going to return money to shareholders in the other two vehicles that we have which are share repurchase and dividend. So I want to make sure that people understand that those three vehicles can be -- are not mutually exclusive. They can be done concurrently, but we will accelerate one versus the other as we progress as I said, money will not sit in the balance sheet unused.
Thank you, Joe.
Thanks, Vijay.
Thank you. And the next question comes from Larry Keusch of Raymond James. Your line is now open.
Thank you. Good morning everyone. Joe, I obviously caught the comments related to share being stable in IV solutions. I think one concern that investors have is that as we go through contracting process and contract renewals, given some of the pricing around the spot market et cetera, that pricing overall could start to come down. So I was hoping you could perhaps provide a little bit of color and I guess in that maybe some thoughts around just given the tremendous job that you guys have done with creating redundancies for supply, how that also resonates and factors into some of those discussions.
Listen, we were not the benefactors of the spot market sale, because when we end up having -- before we create all this flexibility in our supply chain in Americas, which today is second to none. We have that ability. It's so strong that we can guarantee with penalties to our customers the contracts that we would supply them product, okay? But when we didn't have -- not have that, the other -- the competitors who are selling their product to our customers, were selling sometimes in the spot market with higher prices. So we are not the ones who mostly benefit from that. So I would say pricing in the markets are established by contracts. We have a stable contracts and a stable share. But pricing is a function of competitiveness and that -- so we will always be competitive in the marketplace. But we have what most companies today competing with those don’t have, we have volume of manufacturing, but we have redundancy plan. Think about where we are now approved to sell into the U.S. We can sell our -- out of our plant in the Carolinas, we can sell in the U.S products made in Ireland, products made in Mexico, and products made in Brazil. So we can with the flip of a switch very quickly build inventory contingencies across the Americas, and I think that is a very important position. So how does the price play in this is that, listen, we don't control price other than negotiations which are given -- who are between us and our customers. We did not benefit from this spot markets. So if you are thinking about seeing a decline in price in our contracts in 2019, those will not be there because we're not the ones who jacked up the price for a spot sale and took advantage of that.
Okay, perfect. And just one clarification, and then a follow-up. The clarification is the -- I know you worked hard with the FDA to get clearance for a lot of those facilities to bring supply into the U.S. I just want to make sure that those are permanent approvals to bring supply in. And then the second question, Joe, I wanted to just touch on M&A perhaps in a slightly different way which is, obviously, Amy Wendels come onto the Board of Directors, she is someone that you've worked with for a long time. She has been very, very impactful at Covidien relative to the M&A strategy. And so I just wanted to pick your brain a little bit on the implications of her joining the Board?
Okay. So listen, going back to the first part of the question and in terms of what is permanent. Mexico is permanent. Brazil is temporary right now, going to permanent after a second inspection that we are expecting from the FDA shortly. Ireland is permanent and we are going to eventually hook up Canada as well as soon as we line up inspections from the FDA. But if you think about Mexico, Mexico is permanent for us, that's a humongous amount of volume that we can bring into the U.S and divert into other places in Latin America as we wish. So there is a lot of flexibility. So Mexico brought -- if you think about a 100% flexibility, Mexico brought to us 85% of flexibility to the supply chain. And the other 15% were brought by Ireland and eventually when Brazil gets permanent importation status, which will happen in 2019.
Great. And then Amy?
Oh, and the second part, about Amy, well I'm so happy Amy is joining the Board. Amy was a colleague of my at Covidien for many years and work with me for 20 plus years at Covidien. So and -- Tyco Healthcare and Kendall Company. So we go back 1995. She will be instrumental on the Board in helping is not only M&A. Amy is a strategist, is a healthcare strategist. She is excellent in that area and we are very excited that she will be part of helping us with her strategy as well as making sure that our team is in the best shape ever. This is great news for Dennis [technical difficulty].
Thank you, Joe.
Thank you. And our next question comes from Danielle Antalffy of Leerink. Your line is now open.
Hey, good morning, everyone. Thanks so much for taking the question and congrats on a strong quarter. To exit the year, Jay, I know how much you love to talk about cash flow and not to nitpick on the quarter, but cash flow did come in a little bit under the updated guidepost Q3 for the year. Wondering if you could talk a little bit about that and what the drivers for the cash flow guidance for 2019 are? Thanks so much.
Certainly, Danielle. Thanks for the question. As you know I do always focus on cash flow, it's a critical number for us. From a fourth quarter perspective in 2018, actually -- it actually was quite a good quarter, right? Operating cash flow growth of 50% nearly and free cash flow growth essentially double and we grew $270 million to over $500 million. So very solid performance. But cash flow is admittedly a number that it's very back end loaded. A lot of the activity, roughly 40% of the cash flow in the year comes in the fourth quarter and a large component of that comes in December. And whenever you try to forecast performance in a month, there is a lot of choppiness to that. And so we -- to your point, we did comment a little bit below our expectations. The reality is there were few factors in play. The sales mix came in a little bit different with more drugs and less devices. Some of the devices that we had earmarked to place in Q4 moved to Q1 with no implications to long-term revenues, solid customer demand. But like I say, it's difficult to anticipate exactly when devices will go out the door. And then the final factor which is an interesting one, is some of our sales over performance came in December and whenever that happens you get the inventory benefits to cash flow, but you don't get the payoffs in the receivable collection even if you have a 30 day DSO, you’re collecting -- if you make a sale in December, it's not going to show off until January. And so, you put all these factors in play, I mean, cash flow did come in a little bit below our expectations. But I will tell you anytime, we grow free cash flow 16%, 17%, which is basically what it was for the year, largely in line with earnings growth and I think it's a decent performance. And so as we look forward, we will have a solid -- we have solid line of sight. What I hope that we have made some improvements to our process to get a better handle on December, but we use the word approximate when we talk about cash flow guidance for this very reason, and it tends to be the most volatile number we forecast. But like I say, our conversion ratios are continuing on to a very good extent. This continues to remain a focus for our entire organization. And in fact, later on today, Joe and I have a meeting with our supply chain team, discussing our -- some improvements to our S&OP process. And we brought in a new leader to this area, supply chain, S&OP process is really the sales and operations planning process that we have at the company. So opportunity there, but, by and large, a very solid cash flow year.
Great explanation. Thank you so much.
Thank you Danielle.
Thank you. And our final question comes from the line of Matt Miksic of Credit Suisse. Your line is now open.
Hey, everybody. Thanks for squeezing me in.
Hi, Matt.
Hey, how are you? And congrats on a really strong end of the year. So I couple of clarifications here just on guidance and one on capital deployment. So maybe for Jay, just a clarification on Q1. The color on the 230 basis points of nonrecurring growth items in that 1% to 2% growth guidance was extremely helpful. If I look at that, right, I just want to make sure we are looking at this the right way, this would put sort of growth -- underlying growth, if you will, closer to 3.5% to 4.5% for the first quarter ex those items. And I’m just wondering, if that’s true, just maybe flesh out the impact on the bottom line. I get about $0.05 to $0.07, but anything you could do to quantify that or color around that would be helpful? And then as I say, one question on capital deployment.
Certainly. So in the first quarter, you're right, Matt, BREVIBLOC is $35 million. It's like 1.3%. The IV buy-in and in-center HD are another two factors, adding about 1%. So it is a fairly substantial impact. I will stop short of adding those to the reported operational growth number to come up with this fictitious adjusted number. I don't want to do that, but you can certainly do that to get a more accurate long-term representation of what the growth rate will be. We try to be judicious at using adjusted financial measures here. But then from an EPS headwind standpoint, it's actually more than that, because BREVIBLOC is a $0.05 headwind. Cyclo is a $0.01 headwind. Now that's not included in the operational sales growth number, but it is, of course, included in the EPS number. So that's a $0.01 headwind. And then foreign exchange is also a $0.03 headwind. Now we’ve a number of good guys, things like share count and so on. But like I say, those are $0.09 of specific headwinds to the first quarter that, by and large, are the most pronounced in the first quarter of the year. So you point to we do have a bit of a decline in EPS in the first quarter before we see the acceleration. But really, those are the key factors that impact that. I would say that the IV buy-in is also probably about $0.01 of impact to earnings with the in-center HD is less than that because it is a low margin business. So that’s really the overview.
Okay. Now that's super helpful. And on the follow-up, I guess taking kind of a similar analysis to the full-year, and I understand your organic growth guidance is your organic growth guidance of 3% to 4%. But if we look at the 130 basis points kind of in a similar way, one could argue sort of the underlying growth of your businesses is already kind of tracking into that 4% to 5% long-term growth CAGR that you’ve talked about through 2020, at least and that’s our analysis, of course. But on the strategic front, I just want to confirm and clarify the thoughts on urgency for a deal. I think there's a perception that a deal is maybe more urgent somehow to get to this 4% to 5% growth and -- or whether potential enhancements to the portfolio and growth and so on, strategic investments would be additive to those long-term goals. Just any sort of clarifying thoughts you have on that as we wrap up the call?
Matt -- no Mike. Sorry for that, Matt. I know you’re Matt and now I've called you Mike. Matt, first of all, the worst thing that any of us can do here at Baxter is to rush into a deal just to make sure that it helps us in the short-term. And usually those decisions are bad and ill-conceived ones. We are looking for deals for a while, that’s why we’ve a strong M&A team onboard. But that doesn't mean that we are desperate for a deal, we're not. As a matter of fact, we've turned many deals down. And I can tell you we may -- we did this in the last three quarters. We've turned deals down because financials were not there. We couldn’t make ends meet when we -- but we continue to explore every opportunity. We work very closely with our Board in terms of creating a strategic intent, a strategic drive to bring the deals onboard. It has to be strategic. It has to be accretive. It has to return financially, it has to be a company that will benefit Baxter in the long-term. So if we don't find it, we use the money for something else and benefit the bottom line of the company like we did at the end of '18. But there's no urgency. I want our investors to know that this thing of having to make a deal to make '19 happen or '20 happen, it will help us get even better, but it doesn't mean that we need them. And we will not make stupid decisions to get to the -- to a number just because we have the cash. Thank you.
Thank you.
Thanks, folks.
Thank you. That concludes our question-and-answer session for today. Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may all disconnect. Everyone, have a great day.