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Baxter International Inc. (NYSE:BAX)

Q4 2008 Earnings Call Transcript

January 22, 2009 8:30 am ET

Executives

Mary Kay Ladone – VP, IR

Bob Parkinson – Chairman, President & CEO

Rob Davis – Corporate VP & CFO

Analysts

Mike Weinstein – JP Morgan

Rick Wise – Leerink Swann

Bruce Nudell – UBS

David Lewis – Morgan Stanley

Ben Andrew – William Blair

Kristen Stewart – Credit Suisse

Operator

Good morning, ladies and gentlemen, and welcome to Baxter International fourth quarter earnings conference call. Your lines will remain in a listen-only mode until the question-and-answer segment of today’s call. (Operator instructions) I would now like to turn the call over to Miss Mary Kay Ladone, Vice President of Investor Relations at Baxter International. Miss Ladone, you may begin.

Mary Kay Ladone

Thank you, and good morning everyone. And welcome to our Q4 2008 earnings conference call. Joining me today are Bob Parkinson, CEO and Chairman of Baxter International; and, Rob Davis, Chief Financial Officer.

Before we get started, let me remind you that this presentation, including comments regarding our financial outlook, new product 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 expectation. Please refer to today’s press release under SEC filings for more details concerning Baxter that could cause actual results to differ materially.

In addition, in 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.

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

Bob Parkinson

Thanks, Mary Kay. Good morning everyone, and thanks for calling in this morning. We’re pleased today to announce our financial results for the fourth quarter and full-year 2008, and also provide our outlook for 2009. Rob will provide more details in just a few minutes, but let me first start by saying that 2008 was an outstanding year for Baxter. We believe we’re very well positioned for 2009 and beyond.

First, we exceeded all of our financial objectives for the year, achieving record sales, earnings, and cash flow, despite a very challenging global economic climate that developed particularly late in the year. Worldwide, we succeeded in driving growth through geographic expansion, leveraging the momentum of our existing businesses while concurrently pursuing selected new business development opportunities and exonerating our investment in research and development to its highest level in the company’s history.

Adjusted EPS at $0.91 exceeded guidance for the quarter and increased 20% versus the prior year. Full-year adjusted EPS at $3.38 per share increased 21%, and exceeded our original full-year EPS guidance range of $3.10 to $3.18 per share.

Sales growth for the quarter, excluding FX, was robust, increasing 9%, which clearly reinforces the value and strength of our diversified business model and illustrates the solid fundamentals underpinning our portfolio. I’m also particularly encouraged with the consistency of our improving margins. Adjusted growth margins in the fourth quarter and full-year was approximately 51%, a historic level for the company.

Adjusted operating income as a percentage of sales was 22.6% in the fourth quarter and approximately 22% for the full-year, which represents an improvement of over 100 basis points versus 2007. As we look forward beyond 2008, we continue to be enthusiastic about the margin expansion opportunities derived from improved product and business mix, intense focus on pricing opportunities, and disciplined control of manufacturing costs and productivity improvements throughout our global manufacturing footprint.

Throughout 2008, each of Baxter’s global businesses continued to – or contributed to our overall performance financially, operationally, and strategically. So I’d like to take just a moment to highlight some of – a few of the achievements from across all three businesses.

First, starting with medication delivery. We expanded our presence in the global anesthesia market with the continued success of SUPRANE, augmented by the launch of Baxter’s sevoflurane in nine new markets across Europe. Our global anesthesia sales totaled more than $450 million in 2008, improved 10% for the year.

I’d also like to highlight our nutrition business, which was the fastest growing business within medication delivery in 2008. Annual sales of our nutrition business increased 13% in 2008 and now exceeds $600 million on a global basis, primarily, as a result of the increased demand for our proprietary multi-chamber container outside of the US. We launched our V-Link Luer-Activated device, the first needle-less IV connector containing an antimicrobial coating that has been shown to kill 99.9% of specific common pathogens that cause catheter related bloodstream infections including MRSA or Mersa. We completed a study of 50 patients using HYLENEX for pediatric hydration. HYLENEX enables the dispersion and absorption of fluids and drugs. Results from this study will be published in 2009.

And on the COLLEAGUE front, despite some disappointments in 2008, we did continue to make progress. We’ve now remediated more than 100,000 of the COLLEAGUE single channel pumps and continue to be in active dialogue with the FDA, relative to additional software modifications, the clinical evaluation of pump enhancements, and potential changes to complete our current remediation plan. For this reason, we’ve elected not to include revenue related to the US commercialization of COLLEAGUE in our 2009 guidance. We do hope to have more details to share with you in the coming months. In addition, we continue to move forward with a number of other initiatives that reflect our continued commitment to our infusion system business.

In the renal business, Baxter played an important role in supporting the passage of US Medicare reforms that are expected to make peritoneal dialysis a more competitive therapy option in the years ahead. Specifically, the provisions eliminate incentives they currently favor, the prescribing a hemodialysis, and provide reimbursement for free end stage renal disease education. Studies have shown that given an unbiased, objective education on treatment options, about 50% of all patients would choose home therapy versus 8% of patients on PD today. These provisions have already been approved and become effective in 2010 and 2011.

Excluding the impact of the Mexico tender, which we spoke of previously, we achieved 7% growth in PD patients in 2008. This was driven by increased penetration in the developed markets in double-digit patient gains in China and the rest of Asia. We continue to strengthen our global leadership position, and expand geographically as governments, particularly in the developing world, focus on providing increased access to treatments for patients with end stage renal disease.

And we also continue development to expand our leadership in home dialysis therapy with our partner, DEKA on a home hemodialysis device, which progressed well throughout 2008. We’ve now completed development of a prototype, and expect to begin clinical trials in 2009, leading to an anticipated market launch in 2011.

And finally, within bioscience, we’re very pleased with the continued success of ADVATE. With annual sales of more than $1.5 billion, ADVATE has now established the leadership position in the US, Europe, Japan, Australia, and an array of other companies. And we continue to expand this position with an industry leading range of dosage strengths, which enables more precise dosing and increased convenience for patients.

Also in the area of hemophilia, we’ve made progress in the development of a recombinant form of von Willebrand Factor, another protein critical to clotting for people with von Willebrand disease. Von Willebrand disease is the most common hereditary bleeding disorder involving men and women. And recently, we announced the initiation of a phase one clinical program.

And in therapy, we initiated three phase three clinical programs with the intent of expanding improved indications for GAMMAGARD LIQUID or IGIV. These trials include, one, evaluating the use of GAMMAGARD LIQUID for multi-focal motor neuropathy or MMN, a rare neurological disorder characterized by progressive limb weakness primarily affecting the upper extremities; and another, for the treatment of Alzheimer’s disease. In addition, we recently announced the start of the phase 3 trial combining GAMMAGARD LIQUID with enhanced Halozyme’s proprietary drug delivery technology for subcutaneous dosing of IGIV to patients with primary immunodeficiency disorders. Subcutaneous administration of GAMMAGARD LIQUID via a single site could allow patients to administer their dose of IGIV once monthly at home.

In regenerative medicine, we continue to augment our biosurgery portfolio with the launch of ARTISS, the first and only slow setting fibrin sealant indicated for use in adhering skin grafts in burn patients, and with the launch of the GELFOAM Plus, a hemostatic device for use in surgical procedures. We also advanced several programs with our partner, Kuros Biosurgery AG, focused on the development and commercialization of a portfolio of hard and soft tissue repair products, which if successful, will allow us to enter the fast growing Orthobiologics market.

And finally, in the vaccine business, we advanced both our pandemic EMEA and our influenza programs. We’re currently conducting two phase three clinical trials utilizing our seasonal influenza vaccine candidate. And we’ve recently received a positive opinion in Europe for our candidate pandemic vaccine, which provides us with a license and ability to market the vaccine in the event of the pandemic.

So all in all, it’s been a very productive year. Just to briefly summarize, consistent with our strategic priorities, we accelerated, on an adjusted basis, overall R&D spending in 2008 by 20% to almost $900 million, a record level for the company; we received approval for our launch, an array of new products during the year; initiated eight major phase three clinical trials; advanced numerous early stage internal programs; and, established new partnerships with companies like Netdart [ph], Nycomed, and Innocoll, just to name a few.

In 2009 and beyond, given our strong foundation and financial flexibility, we’ll continue to advance our product pipeline. And do so with disciplined project management and increased productivity while balancing the pipeline with both short and long term opportunities, and always with a continued focus on value creation.

So with that, let me turn the call over to Rob for a more detailed discussion on our Q4 results, also our outlook for 2009. And when Rob concludes his commentary, I have just a few additional comments and perspectives this year before we then open up the call to Q&A. So Rob?

Rob Davis

Thanks, Bob, and good morning everyone. As Bob mentioned, we are very pleased with our fourth quarter results, which included strong organic sales growth, continued margin expansion ,and earnings that exceeded our guidance. We are also very pleased with our ability to generate strong cash flow, and to deliver strong significant value to our shareholders through our disciplined capital allocation strategy.

Let me briefly walk you through the P&L by line for Q4 before providing you with the details on our financial outlook for 2009. Starting with sales, our reported sales in the quarter totaled approximately $3.1 billion and increased 4%. Excluding foreign currency, sales growth of 9% exceeded our guidance of approximately 7%, and was driven by better than expected recombinant sales; robust growth across all major product categories within bioscience; and, strong growth in medication delivery, particularly, in the global injectables business. Sales growth in the US was 6%, the highest quarterly growth of the year. This was a result of consistent double digit sales growth for bioscience and an acceleration of growth in the medication delivery business.

International sales increased 3% on reported basis. And excluding foreign currency, sales growth was 10%, with strong growth across all regions in most major product categories. Year-to-date, sales increased 10%. And sales growth, excluding foreign currency, was 6%.

I’d also like to remind you that in 2008, we annualized several items that created difficult growth comparisons for us over the past year or so, like the transfusion therapies divestiture BeneFIX, propofol, and the Mexican PD tender, which all in total impacted our 2008 full-year sales growth by approximately two to three percentage points.

In terms of individual business performance, let me start with medication delivery, which had fourth quarter sales totaling approximately $1.2 billion, an increase of 2% on a reported basis. Excluding foreign currency, medication delivery sales accelerated and increased 7%, which on an organic basis represented the highest quarterly growth rate of the year. This acceleration was primarily driven by improved growth in the US where sales increased 5% driven by solid performance of IV therapy and anesthesia products and positive growth in the global injectables business for the first time this year.

International sales in medication delivery declined 1% on a reported basis. But excluding foreign currency, sales increased 8%. For the full-year, medication delivery sales of $4.6 billion increased 8%, and excluding foreign currency, sales were up 5% exceeding our full-year guidance of approximately 4% of growth.

Turning to the product categories, IV therapy sales in the fourth quarter totaled $393 million and increased to 1%. Excluding foreign currency, sales increased 7% and continued to be driven by solid demand for our IV solutions globally, US pricing improvements, and strong growth in our nutrition business.

Infusion system sales totaled $222 million in the quarter and declined 6%. Excluding foreign currencies, sales declined 2% as COLLEAGUE remediation revenues were more than offset by lower sales of access sets.

Sales of global injectables increased 8% to $420 million as a result of strong growth in the US. US sales increased 11%, the strongest growth of the year as the negative comparison for heparin was more than offset by mid-teens growth in our pharma partnering business and strong growths of certain pre-mix and multi-sourced generic drugs. The international growth was once again the result of solid growth in our pharmacy compounding business.

And finally, anesthesia sales totaled $131 million and increased 4%. Excluding foreign currency, sales increased 7% driven by the global penetration of SUPRANE and growth of sevoflurane.

Moving on to renal, fourth quarter sales totaled $557 million, and declined 7% on a reported basis. Adjusting for foreign currency, sales declined 3%. This was the continued result of a decline in hemodialysis sales and the difficult comparison created by the loss of the Mexican PD tender in the first quarter of 2008.

Renal sales for the full-year totaled $2.3 billion, an increase of 3%, with currency contributing five points of this growth. Excluding foreign currency, therefore, sales declined by 2%.

Globally, PD sales totaled $458 million in the fourth quarter and declined 5% on a reported basis. Excluding foreign currency, global PD sales were down 1%. Excluding both the impact of the lost tender in Mexico and foreign currency, international PD sales were up approximately 4%, and global PD sales also increased 4%. This growth is due to the expanded use of peritoneal dialysis in many developed and emerging markets around the world. In the US, we continue to see positive PD patient growth, which resulted in a 7% increase in US PD sales. Hemodialysis sales in the fourth quarter of $99 million were down 18%, and excluding foreign currency, sales declined by 12%.

Turning now to bioscience, bioscience sales totaled approximately $1.4 billion and increased 12%. Excluding foreign currency, bioscience sales increased 17% with double digit growth across all major product categories. For the full-year, bioscience sales grew 16% to $5.3 billion. And excluding currency, sales increased 13%, which exceeded our expectation of more than 10% growth.

Recombinant sales in the quarter of $506 million increased 9% on a reported basis, and are up 14%, excluding the impact of foreign currency. As Bob mentioned earlier, ADVATE sales of more than $1.5 billion for the full-year exceeded our original expectations. While ADVATE conversion in Europe remained over 90%, international sales were still robust and increased 20% for the quarter on a constant currency basis. US recombinant sales increased7%, and conversion to ADVATE continues. In fact, we ended the year with US conversion of more than 60%, compared to conversion of just over 50% in the US last year.

Turning to the plasma business, in the quarter, plasma protein sales of $330 million increased 10%. Excluding the impact of foreign currency, plasma protein sales increased 12%. Performance continues to be driven by strong demand for plasma derived factor VIII, albumin, and ARALAST as well as improved pricing. US plasma protein sales increased 18%, while international sales increased 5% on a reported basis, or 9% on a constant currency basis.

Antibody therapy sales increased 10% to $309 million in the quarter. And excluding foreign currency, antibody therapy sales grew 14% driven by strong demand for GAMMAGARD LIQUID and pricing improvements.

Sales in the regenerative medicine business totaled $101 million, and increased 6%. Growth excluding foreign currency was 12% in the quarter as a result of strong growth of both FLOSEAL and COSEAL.

Finally, revenues in the other category totaled $113 million, and included a large vaccine order of approximately $50 million that we discussed with you last quarter.

Now, turning to the rest of the P&L and starting with gross margin, adjusted gross margin in the fourth quarter of 51.2% improves sequentially by 60 basis points, and improved year over year by 180 basis points. This margin expansion is a result of favorable foreign exchange, improved business and product mix, pricing improvements across multiple businesses, and manufacturing efficiencies. For the full-year, I’m pleased to report that our gross margin of 50.7% improved 170 basis points versus the 49% we achieved in 2007. And as Bob pointed out earlier, we believe we have further margin expansion opportunities over our long range plan.

Turning to SG&A, SG&A of $674 million in the quarter increased 3% compared to the prior year. Excluding foreign currency, SG&A increased in mid single digits. SG&A as a percentage of sales was 21.5% reflecting a 20-basis point reduction versus the prior year. For the full-year, SG&A increased 9%, with foreign currency contributing approximately three points of growth.

R&D spending of $219 million increased 6%, and excluding currency, R&D grew in the high-single digits. For the full-year, R&D spending of $849 million increased 20%. This growth is a result of investments we’re making across all three businesses, particularly in many of the programs that Bob mentioned earlier in his opening comments.

Interest expense was $14 million, compared to $12 million last year. And other expense was $1 million in the quarter, compared to $4 million last year.

Our tax rate in the fourth quarter of 17.3% was slightly lower than our guidance and reflected the impact of the R&D tax credit as we discussed with you last quarter as well as adjustments to valuation allowances. Excluding these items, our operational tax rate remains at approximately 19%.

Finally, as previously mentioned, adjusted EPS in the fourth quarter was $0.91, an increase of 20%. And adjusted EPS for the full-year of $3.38 increased 21%.

Turning to cash flow, we had another very strong year. Excluding the $240 million pension contribution in the fourth quarter, cash flow from operations for 2008 totaled more than $2.7 billion. This represents more than a $400 million improvement over the $2.3 billion of cash flow reported last year, and exceeded our original cash flow guidance of $2.5 billion. Including the outflow related to pension contributions, cash flow from operations totaled $2.5 billion, an improvement of than $200 million versus the prior year.

Our total DSO, which ended the year at 50.6 days, improved five days versus the last quarter, and is approximately three days lower than last year. Inventory turns of 2.5 turns were also better than last quarter, and were flat to last year.

Capital expenditures for the year totaled $954 million as we continued to invest in appropriate capacity across our businesses to support our future growth.

And, lastly, as we commented on in this morning’s press release, during 2008, we paid dividends totaling approximately $550 million and repurchased 32 million shares of common stock for approximately $2 billion. On a net basis, this amounts to repurchases of 18 million shares or $1.4 billion, which exceeded our commitment of $1 billion for the year.

Overall, I’m particularly pleased with our ongoing ability to generate strong cash flows. We continue to return significant value to shareholders as a result of our improved financial flexibility, capital allocation strategy, and disciplined financial management while accelerating investments in R&D both internally and through selective business development activities that will position us well for future growth.

Finally, let me conclude my comments this morning by providing our financial outlook and guidance for 2009. As you saw in the press release, we expect earnings of $3.70 to $3.78 per diluted share. This guidance reflects a potential modest impact to sales due to the uncertainty in the global macro environment, continue the expansion of gross and operating margins, select investments in marketing and promotional activities to support our growth going forward, and increased R&D spending.

More specifically, we expect full-year sales growth, excluding the impact of foreign exchange, of approximately 7%. We expect our reported sales growth to be approximately flat to 2008, which does assume current exchange rates.

For the full-year, we expect gross profit as a percentage of sales to improve by more than 150 basis points, reflecting continued expansion in bioscience, improved profitability in medication delivery and our core PD business, and to benefit from foreign exchange. We expect annual R&D growth in low single digits. Given that more than 40% of our R&D is outside the US, however, this growth rate is dampened by the stronger US dollar. Therefore, on a constant currency basis, R&D is increasing approximately 10%.

We expect SG&A to decline in the low single digits. However, this growth rate is also impacted by a stronger US dollar. And on a constant currency basis, SG&A would increase in low to mid single digits. We expect to tightly manage general and administrative expenses, especially in light of the current environment, while investing in marketing and promotional activities to support the growth of our higher returning and higher growing products.

We expect to continue our trend of year-over-year operating margin improvement in 2009 with an improvement of approximately 200 basis points to approximately 24%. We expect interest expense of between $90 million to $100 million, and other expense to total approximately $60 million. We expect our tax rate to approximate 18.5% to 19%. And finally, we expect a full-year average share count of 615 million to 620 million shares as a result of our share repurchase activities. From a cash flow perspective, we expect cash flow from operations to exceed $2.6 billion in capital expenditures to total approximately $1 billion.

Now, to expand on the sales assumptions for each of the three businesses. For the full-year 2009, we expect renal sales, excluding the impact of foreign currency, to increase in the range of 4% to 6%. This is the result of solid, single digit growth in PD, and flat to declining HD sales.

For medication delivery, we expect sales excluding foreign currency to also grow in the 4% to 6% range. This will be driven by several factors, first, at constant rates, we expect anesthesia to grow in low double digits due to demand for SUPRANE and additional market launches of sevoflurane; second, we expect the IV therapy and global injectables businesses to grow in mid single digits, and lastly, we expect infusion system sales to be flat due to lower COLLEAGUE remediation revenues year-over-year.

Finally, for the bioscience business, we expect sales growth, excluding foreign currency, to once again exceed 10% driven by strong growth across the portfolio. First, we expect recombinant sales growth in high single digits. Second, we expect plasma protein and antibody therapy sales to grow in mid-teens driven by improved pricing and strong demand. Third, we expect the regenerative medicine business to again grow in mid-teens. And finally, we expect the other category, which includes our vaccines business, to grow in mid single digits.

For the first quarter, as we mentioned in our press release, we expect earning per diluted share of $0.80 to $0.82, and sales growth, excluding the impact of foreign currency, of approximately 7%. Based on current foreign exchange rates, we expect our reported sales in the first quarter to be approximately flat to the first quarter of 2008.

In summary, our 2009 guidance reflects the ongoing operational strength of our businesses and ability to deliver sustainable growth. It is in line with our long range strategic and financial objectives. Although we are operating in a volatile and challenging macro environment, the potential effects of which continue to evolve, we remain focused on delivering growth while making appropriate investments for the future.

Now, I’d like to turn the call back to Bob.

Bob Parkinson

Thanks, Rob. Before we open up the call to Q&A, I’d just like to make a few closing comments. Clearly, 2008 was a very successful year for Baxter financially, operationally, and strategically. And while we’re certainly not without challenges, we believe our company is very well positioned for 2009 even in today’s challenging global macro environment. The progress that we’ve made over the last several years to improve the quality of our balance sheet and financial performance will provide flexibility and yield great benefits in the coming months and years.

The global economy will continue to struggle for the foreseeable future. And companies in many industries are faced with unprecedented economic challenges. While no company, including Baxter, is completely immune to potential impacts given the medically necessary nature of our products, our diversified healthcare model, and strong market positions, we’re confident in our ability to drive improved performance and grow even in this uncertain environment.

Our 2009 outlook is aligned with the solid underlying fundamentals we see in the markets in which we operate, and we remain committed to driving growth while investing in innovation and building business development activities that position us for the future.

We look forward to seeing many of you at our investor’s conference on September 16th of this year in Chicago. At that time, we’ll provide more insight into a number of our R&D programs in all of our businesses and we’ll also provide a longer term outlook on the financial performance of the company with particular focus on strategic business segments that are critical to our future. In the meantime, we begin 2009 well positioned for continued success. So with that, we’ll open up the call for Q&A.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. (Operator instructions) Our first question comes from Mike Weinstein of JP Morgan. Your question please.

Mike Weinstein – JP Morgan

Good Morning. Congratulations on another good quarter. Let me start by asking a few financial questions. That’s probably helpful. I would say, one with the 2009 guidance if you could, I think it would be helpful for everybody if you could talk a little bit about the gross margin drivers. You’re currently for more than 150 basis points of improvement again in 2009. I think added to the commentary as to – as the drivers behind that would probably be helpful for people. To the shares, your stated guidance, since implied of $550million of net repurchases based on when the stock is at today, is that right? And then third, $1billion in CapEx in 2009 is higher than what we’re modeling. So if I could get some insights on that. Thanks.

Bob Parkinson

Okay. Thanks, Mike. Let me start with the gross margin discussion, and Rob can think a little bit with responding to the buyback question and the CapEx. As we discussed previously, there’s a number of factors that give us a basis of optimism, I think, in terms of continued gross margin expansion going forward. It starts with, what I recall, business mix as you listen to a lot of detail on guidance for next year. Clearly, our bioscience businesses projected to grow at a faster rate than the other businesses. As you know, it is a higher margin business. And so, that is a continued contributor to gross margin expansion.

Having said that, with any each of our businesses, particular business units that have higher gross margins are growing at a faster rate. We highlighted, in medication delivery for example, with growth year-to-ear ’08 versus ’07 of our anesthesia business, again our nutrition business. Both of which have higher gross margins than medication delivery overall. And again, for ’09 we’re projecting these business units to grow at faster rate than medication deliveries. So that was our examples of business units that are higher margin growing at a faster rate.

So again, business mix led by bioscience business unit mix within the various businesses, all of our higher growth vehicles can be business units or businesses that are higher gross margins. Of course, the hallmark of our company is our focus on manufacturing efficiencies, yield improvements in our bioscience business, value improvement programs in medication delivery, in renal, and so on. And we continue to pursue manufacturing efficiencies in our global manufacturing footprint with a passion.

The final thing I would say, Mike, is our focus on price. And we are pursuing price aggressively in those businesses or business segments where we think opportunity exist. We’re all aware of the pricing opportunities that continue to exist within plasma proteins, but our pricing improvement story is actually much broader than that. And a good example of that again being our IV business in the US where we’re experiencing price improvements to a greater degree than we have in years.

So those are really the primary drivers for gross margin expansion. I don’t know if you want to add anything to that, Rob before we move on to the other two pieces of Mike’s question.

Rob Davis

No. I think –

Bob Parkinson

Okay, why don’t you address the buyback question and also the CapEx projection for next year.

Rob Davis

Sure. Actually Mike, we’re assuming on a net basis $750 million of purchases. So it could be just in the later phase in those. But that’s currently what we’re operating to. And obviously, as we move through the year, that’s something we will continue to evaluate as we did in 2008.

With regard to the capital expenditures, the $1 billion is really a good story. And what it really tells you is that if we continue to become more confident and continue to grow in our business, as we continue to see the need for capacity expansion across all of the businesses, and to invest in our R&D infrastructure, that’s led us to increased investments from what we originally expected. I’d point out that it’s not due to programs, which are costing more being significantly extended in time. It is truly due to that fact (inaudible) capital investment opportunities to drive growth more than we expected. So that’s really what’s behind the $1 billion.

Mike Weinstein – JP Morgan

Let me just do one follow up here, and then I’ll let others step in here. Bob, you organically 9% of the top line this quarter, which is obviously a very strong quarter for Baxter. You’re guiding at the starting point at 7% for 2009. It would certainly appear and this is a discrete assumption that the economy is not having a significant impact in your business. Are there any touch points that we should be watching within 2009. And then how good is your visibility relative to different businesses right now?

Bob Parkinson

Yes. But there’s a lot here. Let me try to be pretty succinct here. First of all, the 9% was benefited – it benefited, to some degree, based on vaccine sales, and it’s in the fourth quarter. But I think if you look over the last year to – we pretty consistently, when you adjust for FX, the PD divestiture, the BeneFIX loss, and so on, have been running organic growth around the 8% range. Our organic projection for – growth projection for next year, as Rob mentioned, is 7%. Candidly, that reflects some modest impact to, really, the potential impact of the global economic environment in which we operate.

Nobody has a crystal ball. I mean we came for a very well positioned because of the medically necessary nature of our products. Frankly, people are not going to go off dialysis therapy or therapy for hemophilia or immune disorders because of the economy. I would say that if you look at our medication delivery business, we know that many hospitals are experiencing a softening and hospital admissions, to some degrees surgical procedures. Frankly, whether or not those are procedures that consume IV solutions to a great degree, and so on, we don’t really know. And through the fourth quarter, we haven’t really experienced anything. But we saw improvements as we pull together our plans for next year to reflect something there. But I think we have pretty high confidence level that we can deliver the 7% of our organic growth.

The other things in the economy, since you raised it, and this is probably basis for other follow up questions, so we don’t have to address it at the outset. We do believe that we will begin experiencing some DSO deterioration because of the economic environment in 2009. Although, interestingly, in the fourth quarter we had our best DSO quarter in a long time, including in the US. So go figure.

In terms of emerging and developing markets, as that their healthcare budgets get scrutinized, perhaps, reduced to some degree, we may begin experiencing some impact on lower volumes and access to some of the tenders. Although, as of yet, we haven’t seen that. And of course, the other practical area that hospitals are dealing with, particularly in the US, because of gas constraints and liquidity constraints, and so on as CapEx spending. And as you know, we have very little that really is impacted by that. A bit of an irony it may have served to secure our COLLEAGUE base longer. And the channel erosion the we’ve experienced over the last couple of years.

So I’ll stop there. There are other may be specific follow ups to that, Mike, but I’ll just conclude there now.

Mike Weinstein – JP Morgan

Thanks for taking my questions.

Mary Kay Ladone

Hey Mike, it’s Mary Kay. I’d also like to add to Bob’s comments in terms of the sales growth guidance. One thing we didn’t mention in our prepared comments is that transfusion therapy sales will be declining in 2009 to about $50 million for the full-year. That’s versus 2008 of about $170 million. So that also has about a 1% impact on our overall sales growth.

Mike Weinstein – JP Morgan

Great. Thanks for that.

Bob Parkinson

Okay, next.

Operator

Thank you. Our next question, Rick Wise of Leerink Swann is on the line with the question. Please state your question.

Rick Wise – Leerink Swann

Good morning, everybody.

Bob Parkinson

Good morning, Rick.

Rick Wise – Leerink Swann

Bob, let me talk about strategic issue first. Acquisitions, I think, have been on your minds from the beginning as potential growth driver. A couple of parts – do you think the environment is more attractive? Is Baxter now more likely –given what should be better pricing and availability? Are you more inclined than less inclined now in the next twelve months. And if there are any areas you want to highlight? I’d be happy to hear that as well.

Bob Parkinson

Sure. Thanks, Rick. First of all, let me say this, if you look back over the last several years, of course, our PD activities have been limited largely to licensing, acquiring smaller products that are complimentary, and so on. But I think our strategy of focusing internally on really extracting value that exists in our existing core businesses has proven to be the right strategy, given our improved financial results, and not distracting the organization to acquisitions and so on.

I would say that while there continuous to be great opportunity for gross margin expansion going forward in our existing businesses, we are in a position now as a company, both in terms of our improved financial position over the last few years. And I also think, importantly, our organizational capabilities to now be a bit more expansive in evaluating opportunities and perhaps bringing things in, including acquisitions. It’s happening at a time where, as you pointed out, a reference – in your question, the environment is such – or implied in your question, the environment is such that there maybe – it maybe a more target rich environment right now.

And so clearly, we are very open-minded to that. But we’re also very cognizant of our need to be disciplined, and not do deals for the sake of doing deals, but doing deals that we are confident will create value for our shareholders. We’ve got our PD teams evaluating opportunities, we’re looking at it. I think, like I said, we have the financial (inaudible) and now the organizational (inaudible) to perhaps do some things, and you all will be the first to know.

Rick Wise – Leerink Swann

Sounds Good. On COLLEAGUE, you highlighted that you’re not assuming – if everything gets resolved this year. What’s left to resolve if it’s worth discussing? On the competitive front, there have been some major GPO contract then for one of your competitors. And maybe just the last part of that, if COLLEAGUE were to come back, can you help us think what that might mean for any given quarter or any 12-month period incrementally just to put things in perspective. So your want of a resolution to this situation.

Bob Parkinson

Yes. First of all, Rick, relative to the GPO situation, I’m not sure that any of our competitors have carved out a unique position with any GPO that has really created an obstacle for us or a barrier in terms of COLLEAGUE going forward. There have been GPOs that have made multiple awards to all suppliers. But it doesn’t necessarily close the door to us. So I think it’s important to clarify that at the outset.

If you harp in back to the time when we were commercializing COLLEAGUE in the US, we were generating roughly $150 million of sales associated with placement of hardware in any given year. That does not include, of course, the disposable trail vets associated with that. So that’s probably the best kind of high level number I can give you in response to when we get back in a position where we can re-commercialize, what one might expect on an annual basis. I suppose, one can also suggest that there may be some pent up demand and accounts that have not been able to buy COLLEAGUEs. But hopefully, at some point, we’ll be able to. But I don’t really want to speculate what that might be. But that’s kind of an over magnitude response.

Rick Wise – Leerink Swann

Okay. And last quick one, when do you – when should we expect to see the phase three IGIV data, and if there are any other indications of the going clinical trials and mark it up phase that might pop up through the year. Thank you.

Bob Parkinson

Okay. You’re referring to, Rick, on the first part of Alzheimer’s? Okay.

Rick Wise – Leerink Swann

Yes. I’m sorry. Sorry, Yes.

Bob Parkinson

Mary Kay, why don’t you go through the Alzheimer’s as well as maybe some of the other phase three initiatives on Denver?

Mary Kay Ladone

Sure. On Alzheimer’s, Rick, we just started the phase three. So that is an 18-month trial with 360 patients. We’re anticipating right now about 12 months for the patient enrollment, and we will not have an interim (inaudible) data. So it’s going to be a couple of years before you see any phase three results on the Alzheimer’s trial.

You will see, though, in 2009 the phase two 18 months results. And at this point of time, we can’t a time frame for that. That’s really being handled by Dr. Routkin, and when he decides on his opportunity to present that information, we will let you know where that would be and when that will be.

We also have ongoing, as Bob mentioned earlier is his comments, a phase three for MMN. And that’s about a 40-patient trial, 15 months follow up. So that probably won’t be anything until 2010 on MMN.

Rick Wise – Leerink Swann

Thanks very much.

Mary Kay Ladone

Oh and then also we did start, as Bob mentioned, the phase three IGIV trial combined with enhanced – the Halozyme technology. And I know that is also a 12-month trial. So that’ll again, that will be 2010 before you see any data.

Rick Wise – Leerink Swann

Okay. I appreciate it.

Mary Kay Ladone

Next question.

Operator

Bruce Nudell of UBS is on the line for question. Please state your question.

Bruce Nudell – UBS

Thank you. Lots of clients have expressed concerns to us regarding the fact that the economy is bringing more people into the plasma collection centers. Clearly, your ability to take price in plasma products, and whereas some any – almost 10% this year suggest to us that the supply-demand balances is just fine for IVIG in particular. Could you comment on that phenomena with regards to drawing people in the collection centers, and what the kind of relative rates of intrinsic demand versus supply might be for IVIG globally. Thank you.

Bob Parkinson

Bruce, this is Bob. Let me start, and then maybe Rob or Mary Kay could support my comments. First of all, I don’t believe that the number of people coming forward willing to donate plasma necessarily has any impact relative to the overall supply. I think the supply is a function of installed capacity which is, you pointed out, and we continue to believe this is well-balance with demand. And anything, I suppose, it might imply over time, cost of collecting plasma may go down, although we haven’t experienced that to date. But I don’t see that phenomenal which more people, presenting at the plasma centers to donate plasma and get paid for doing that as a really relevant variable in terms of the supply equation. Rob or Mary Kay?

Rob Davis

I would just add that it’s important that – we got this question a lot – it is important to understand that the bottle neck today in the supply side of the equation is the collection capacity in the industry. So you’re running your center at capacity, which we largely are, we’ve been able over 2008 to do a great job. Frankly, our bioscience seems to have done a great job squeezing additional yields from our existing footprints. But once you reach capacity in the center, the number of people presenting doesn’t change the capacity of the people you can live through. So that’s why we continue to believe this has not had any meaningful impact on total collections. I think to Bob’s point, it continues to cause you to rethink how you price the collections, how you market for collections. The other thing I would know to where you have seen some is there are at least anecdotally, report that there is a reduction and people donating plasma, free plasma, if you will full blood to the American Red Cross and some other organizations in hopes of trying to do it to a free base center. But then, if the capacity is limited, that won’t change the total numbers.

On the second part of your question, we continue long term to believe we’re going to see or promote total market perspective, growth, and volume of the highest single digits and growth in price of low to mid-single digits longer term. We did better than that in both categories in 2008. And we will see how it turns out in 2009. I think the important thing here, and we’ve talked a lot about this externally, is really to understand the demand side of this picture. We are increasingly confident in the robustness and sustainability of the demand. As you heard, we’re driving new indications; we’re seeing clear for demographics.

So all the factors are really driving the demand stronger. And to us, that’s the real key that gives us the confidence of sustainability. Now all we have to do as an industry is to make sure we keep supply up with demand, keep it in balance, and we’re confident we can do that. So no change in our view of stability, no change in what we see as collection growth. It’s (inaudible) gross.

Bruce Nudell – UBS

Terrific. And just one follow up, can you talk a bit about the dynamics you see in the dialysis segment next year, and how you arrived at, I guess, the mid single-digit growth in PB.

Bob Parkinson

Sure. This is Bob. Bruce, probably, I would differentiate the US market versus, let’s say, emerging developing markets, which continue, as we commented and as you know, to be the primary driver for growth. The most significant event that transpired in the US in 2008, of course, was Medicare legislation that relates to both patient education, to ensure that all patients that need to be treated are aware of the various therapies that are available, including PD. That has not the case. And that’s going to be required in 2010.

And then, of course, new reimbursement, composite rate reimbursement, in 2011, which frankly, we believe will be able to level the playing field in terms of the economics and the economic decision that comes into play in terms of selecting a therapy, HD or PD. So we think these are external events that will set the stage for enhanced PD growth. Perhaps significantly, let’s say, 2011 and beyond. So that’s a very positive development.

We anticipate that in emerging developing markets, China being a great example, we’re going to continue to experience strong growth where many of these markets PD is much more broadly embraced than HD. And to a large degree, it’s because you don’t have some of the economic dynamics that exist in the – in the US market.

As I referenced in my prepared comments and you’ve heard us say before, when presented with options of therapies, 50% of the patients and virtually every country around the world, frankly, would prefer to be on home dialysis. The convenience associated with that from a cost point of view, typically delivering therapy in the home, is a lower cost than in the center for some – I think some obvious reasons. And finally, for many patients, the clinical outcomes are enhanced.

And so, while the last couple of years has been a challenge in our overall renal business in a number of ways, we continue to be very bullish about the long term prospects of the renal business. And I think this is one of the areas we’ll expand on in our September investors conference to give you a little bit more insight as to the basis of our confidence in the years ahead.

Bruce Nudell – UBS

Thanks so much.

Operator

David Lewis of Morgan Stanley is on line for a question. Please state your question.

David Lewis – Morgan Stanley

Good morning.

Bob Parkinson

Good morning.

Rob Davis

Good morning.

David Lewis – Morgan Stanley

Just one follow-up question on demand for Rob’s comments, then two questions on investment maybe for Bob. But Rob, you mentioned a driver being the demand side, not the supply side. Obviously, emerging markets have been a component of that. It looked like international growth in some of the bioscience units would weaken the fourth quarter, obviously, not carrying forward in 2009 guidance. But can you comment on any softness in South America, any of the BRICK countries, Russia or China has (inaudible) market demand for therapeutics?

Rob Davis

The short answer is we saw no softness that would be endemic of anything going on the broader economy. It was really timing of how things moved to the quarters. In fact, in Russia as an example, we had a successful large vendor. So there’s no, I should say, no sign (inaudible) to our 2009 guidance as a complement to that.

Mary Kay Ladone

I also, David, would remind you that we talked about this back in Q3. We had most of our tenders in Q3 this year. And last year, they were in Q4. So we had a really difficult time in – across the plasma protein in 2008 in the fourth quarter.

David Lewis – Morgan Stanley

Okay. Very helpful. And then, maybe about two questions on investment. The first in capital spending, obviously, close to $1 billion this year. What do you think about the level of your investment, you think in the out years, in 2010 and beyond? Does this level investment in manufacturing and fractionation give you the confidence that perhaps in a pricing environment that’s less favorable in 2010 and beyond? These types of investments are going to enable you to still increase gross margins at the kind of rates you’ve seen in store for you of $100 to $150 this year?

Bob Parkinson

I don’t think – regarding the second part of your question, David, given a fairly dramatic ramp up in plasma pricing as you go back over the last couple of years, while we’re confident in our ability to deliver load in this single digit price increases going forward because they’re not going to be the same degree going forward than the past, that particular dynamic will have a modulating of that split. But I would say, relative to CapEx spending, we can extract that kind of $1 billion range going forward. I’m hopeful that that’s the case. Because as Rob pointed out earlier, this is an investment largely in capacity to support not only volume growth of existing businesses, but new indications for products and new products, and so and so.

Now I would expect that around this level, maybe not every year. But I think, really, our annual spending on CapEx has ramped up. And I think it’s a good news story, and we would anticipate that (inaudible).

David Lewis – Morgan Stanley

Okay. And the second question on investment, obviously, would be on R&D. And I wonder, if you think about the growth trajectory of your three major business units and you think about your relative level of R&D across of these units and the progression of the pipeline in those various segments, I wonder if you could tell us right now where you’re feeling more comfortable and where you’re feeling less comfortable.

Bob Parkinson

Well listen, I think we have opportunities – pipeline opportunities in all three of our businesses. And again, I won’t take the time this morning to enumerate those. Having said that, we have ramped up our R&D investment in bioscience at a faster rate than the other businesses. And I think for some fairly obvious reasons, I think what I’m excited and most pleased about, as I reflect back on the last four or five years, is that as a result of our improving financial performance, we have been able to fund a fairly dramatic ramp up in R&D.

And the nature of our pipeline has changed. Because if you go back five years ago, most of the stuff were really near term kind of opportunistic kinds of programs. And today, we have a great balance of, yes, some of those kinds of programs, but things of a more pharmaceutical nature R&D in our bioscience business, which are longer term R&D programs. They may have a higher element of risk, but of course, the payback attendant with that is higher, so.

And again, as we mentioned in the prepared comments, we’re projecting again in ’09 to grow R&D at a faster rate than top line organic growth, which is a strategic priority for the company. But again, on this whole R&D question, it’ll be one of the primary areas to focus in our September investor conference because we realize we haven’t been terribly detailed on the pipeline. And that will provide an opportunity, I think, to be a little more explicit that we’ve been in the past.

David Lewis – Morgan Stanley

Okay. Thank you very much.

Bob Parkinson

Yes.

Operator

Ben Andrew of William Blair is on the line for questions. Please ask your question.

Ben Andrew – William Blair

Hi. Good morning. I just wanted to follow up on one quick question. You mentioned during the discussion in the delivery, you saw some lower asset sales in the quarter. Was there something unusual there? Or is that something we should be keeping an eye on more closely for ’09 as well?

Mary Kay Ladone

Ben, we’re looking at that really from a dollar perspective. It wasn’t raw materials that they’re sold – at the sales level and that business is so small – a small amount reflects a larger percentage. So I think we were down $3 million, $4 million, $5 million in the quarter in that respect. It was small.

Ben Andrew – William Blair

Oh okay.

Bob Parkinson

The ideal thing, let me just say after that, just to be very direct, because that’s associated with COLLEAGUE placements and COLLEAGUE channels and so on, we saw no meaningful further deterioration in the fourth quarter of our channel base. So if you see that softness in asset sales, don’t conclude that’s because our channel base of COLLEAGUE in the US declined dramatically. It did not. And it really is more of a quarterly dynamics. And given the smaller numbers, and the percentages, and so on that Mary gave us right.

Ben Andrew – William Blair

Okay. And one other question on anesthesia, you talked about continued geographic expansion, either – maybe what are some of that particular countries you’re going after, or another way to look at it is kind of percentage of opportunity that’s being opened up in ’09? And then, is there a material not more or less for 2010 and beyond to sustain that anesthesia growth.

Bob Parkinson

Well let me comment maybe on the second part of question first, Ben. Yes. There’s material opportunity for growth throughout the LRP, which is why we described anesthesia really as a strategic business for Baxter. As you know, we’re the only company that has the full array of inhalation agents. It’s not a therapeutic area where the current products that are used are being obsolete by next generation technologies. So it’s a great example of our global position. Geographic expansion has helped our budgets grow around the world. Surgical procedures and developing and emerging markets grow at a faster rate. We’re going to be there, very well positioned with the full line of products that participate – to participate in that growth. So yes, this is a long term – this is a long term strategic business and priority for Baxter.

In terms of the first part of your question, markets were going to expand – I don’t really want to get into the detail of that, but there’ll be a number of them. I don’t know, Rob, would you care to–

Rob Davis

I think because of reasons, we don’t want to get into them now. So we’re going to launch.

Ben Andrew – William Blair

Okay. That’s all I have. Thank you.

Bob Parkinson

Okay, Ben. Thanks.

Mary Kay Ladone

Okay. We have time for one more question.

Operator

Kristen Stewart of Credit Suisse is on the line with her question. Please state your question.

Kristen Stewart – Credit Suisse

Hey. Thanks for taking my question.

Bob Parkinson

Sure.

Kristen Stewart – Credit Suisse

I just wanted you to help give us a sense in terms of maybe some of the bioscience products of what percentage would Medicaid be a payer. I know you are all concerned about what some of the reimbursement could look like as states come under increasing financial pressure, and whether or not in this more difficult time, you might see any changes in maybe some of the (inaudible) within hemophilia products.

Bob Parkinson

Sure. Let me start maybe kind of at a high level. And then rather, Mary Kay, you can think about this. And at our hour, we could close up the Q&A here.

We’ve always said that reimbursement pressures exist for our primary products in the purely – including, certainly, in the hemophilia sector and in our bioscience business. And as you know, the vast majority of those patients are non-Medicare. They are, as you pointed out in question, Medicaid reimbursed and evaluated in state by state basis.

So I think that there’s reason to think that given the economic environment, I mean clearly, those pressures are going to continue, but they’ve existed for a long time. There are a lot of dynamics why those pressures have not manifested themselves in a more precipitous climb in pricing. So again, our position with the reimbursement pressures will continue to be evolutionary in nature. We do not see any kind of revolutionary event necessarily that’s going to fundamentally change the slope of that line for the Medicaid reimbursed products. Rob, Mary Kay, if you want to add to that.

Rob Davis

To give you a sense for – the (inaudible) as an example, it’s about 15% under Medicaid. And then, for the – in the field products, a little bit higher. But for both, we still have the majority of our businesses outside of its realm, which are Bob’s points. We see it as evolutionary.

That being said, as we think about – with Bob’s comment on the macro environment and how we think about our 7% organic growth. Obviously, we’ve kind of pointed into all of that as we came up with our expectations for 2009.

Kristen Stewart – Credit Suisse

Okay. And are you seeing anything with Wyeth’s launch of their new plasma and albumin free recombinant.

Rob Davis

No. We continue to believe we’re very well positioned and are very confident of our ability and the value of product relative to others.

Kristen Stewart – Credit Suisse

Thank you so much for taking my questions.

Rob Davis

Thank you.

Bob Parkinson

Thanks, Kristen.

Operator

Ladies and gentlemen, this does conclude today’s conference call with Baxter International. Thank you for participating.

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Source: Baxter International Inc. Q4 2008 Earnings Call Transcript
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