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Baxter International Inc. (NYSE:BAX)

Q2 2009 Earnings Call

July 16, 2009 8:30 am ET

Executives

Mary Kay Ladone – Vice President, Investor Relations

Robert L. Parkinson, Jr. –President & Chief Executive Officer

Robert M. Davis – Chief Financial Officer

Analysts

Matt Miksic – Piper Jaffray

Bob Hopkins- BAS-ML

Benjamin Andrew - William Blair & Company

Michael Weinstein - J.P. Morgan

Frederick Wise - Leerink Swann

Glenn Novarro - RBC Capital Markets

David Lewis - Morgan Stanley

Matthew Dodds - Citigroup

Operator

Good morning, ladies and gentlemen, and welcome to Baxter International second quarter earnings conference 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.

Mary Kay Ladone

Good morning everyone. Welcome to our second quarter 2009 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 developments, 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 and our SEC filings for more details concerning factors 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.

Robert L. Parkinson, Jr.

Good morning everyone and thanks for calling in this morning. We are pleased today to announce our financial results for the second quarter and also provide you with an update on the full year 2009 outlook.

As you all saw in the press release issued earlier this morning, EPS of $0.96 exceeded guidance for the quarter and increased 13% versus the prior year. This was the result of strong underlying fundamentals across the portfolio, operational leverage, improved margins derived from product and business mix, continued intense focus on pricing opportunities, and manufacturing cost improvements, as well as the benefit from our ongoing share repurchase program.

While we continue to be very vigilant in monitoring the landscape in which we operate, to date we've not experienced any meaningful macro economic impact on the underlying demand for our products. As I've mentioned to you all in the past, we continue to believe that we are well positioned, given both our geographic reach and the medically-necessary nature of our product line to meet financial objectives in both the short and the long term.

I am pleased with the second quarter sales growth which, excluding FX, was 8%. And excluding transfusion therapies from both years, increased 9%. This represents an acceleration on a constant currency basis versus the first quarter growth rate of about 7% as strong growth from across the portfolio offset lower-than-expected FSME vaccine sales, primarily in Germany.

Gross margin in the second quarter, as you saw this morning, was 52.4% and operating income as a percentage of sales was approximately 24%. Both key metrics showed significant year-over-year improvement.

In addition, we continue to advance and expand our product pipeline through investments in research and development augmented by business development initiatives.

In the quarter, R&D spending increased 4%, which was low double digits on a constant currency basis.

A few recent achievements that I would like to highlight:

First of all, the completion of patient enrollment in the pivotal Phase III study of GAMMAGARD LIQUID with enhanced for the treatment of primary immunodeficiency disorder (NYSEARCA:PID). Approximately 80 patients who will receive monthly subcutaneous injections have now been enrolled;

Also the testing and evaluation of the H1N1 influenza virus and the start of full-scale production of a commercial pandemic vaccine utilizing Baxter's Vero cell culture technology;

The initiation of a Phase III study, following successful completion of a Phase II trial, evaluating to seal fiber and sealant as a hemostatic agent in vascular surgery. These studies are being conducted for submission to the Food and Drug Administration in support of a broad hemostatis indication for this product in the United States; and

Finally, the signing in the quarter of the definitive agreement with Edwards Life Sciences Corporation for the acquisition of their hemafiltration business, also known as continuous renal replacement therapy, or CRRT. CRRT provides a method of continuous and adjustable fluid removal that can gradually remove excess fluid and waste products that accumulate with the acute impairment of kidney function and is usually administered in an intensive care setting in the hospital.

We are very pleased that we continue to make or exceed our short-term financial goals as reflected by the strong sales and earnings performance for the first half of 2009 while being able to continue to invest in creating long-term value for our shareholders. These results, and also the outlook for the year, validate the strength of the diversified health care model and reinforce our confidence in achieving longer-term objectives as we accelerate the pace of R&D investment.

I am increasingly encouraged by the progress that we're making to spur innovation throughout the company and we all look forward to presenting details on our evolving pipeline at our investor conference on September 16, 2009, in Chicago. Of course, at that time we will also provide you with an update on our longer-term financial objectives and outlook for the company.

As always, I would be happy to address any questions you may have during the Q&A. In the meantime, let me turn the call over to Rob for a more detailed discussion of our second quarter results and outlook for the remainder of 2009. And then when Rob concludes his commentary, I would like to take just a few moments to update you on our H1N1 pandemic program.

Robert M. Davis

As Bob mentioned, we are pleased with our second quarter results, which included continuing margin expansion and earnings that exceeded our guidance. Let me briefly walk you through the P&L by line item before providing you with an update on our financial outlook for 2009.

Starting with sales, our reported sales totaled $3.1 billion and declined 2%. Excluding a 10% impact from foreign currency, sales growth was 8%. Also note that excluding transfusion therapies from both years, reported sales declined 1%, and excluding foreign currency Baxter's worldwide sales growth was 9%.

This growth was driven by an acceleration across all three businesses versus the first quarter, with double-digit growth across most key product categories within BioScience and solid growth in Medication Delivery and Renal.

As Bob mentioned earlier, we have experienced no material impact from the global macro environment,. However, we have faced a weaker-than-expected vaccine season in Germany for the FSME vaccine. This primarily was the result of a longer winter, a severe influenza season, compounded by a difficult comparison to last year.

I would also note that while this affected our first half results, we have largely absorbed this decline and as a result of the seasonality of these sales, with the vast majority of them historically occurring in the first six months of the year, we do not anticipate any material impact on the company's sales performance in the back half of the year due to this dynamic.

With individual business performance, let me start with Medication Delivery, which had a second quarter sales totaling $1.1 billion, a decline of 3% on a reported basis, but excluding foreign currency Medication Delivery sales grew 8%.

U.S. sales increased 4% and international sales in Medication Delivery declined 8% on a reported basis, but excluding foreign currency, international sales were up 11%.

Turning to the product categories, IV therapy sales totaled $384.0 million and declined 6%. Excluding foreign currency, sales increased 7% and were driven by increased demand globally for IV solutions, low double-digit growth of nutritional products, and improved pricing.

Global injectable sales increased 6% to $418.0 million. Excluding foreign currency, sales grew 17% due to strong growth in U.S. multisource generics and our pharma partnering and international pharmacy compounding businesses.

Infusion systems sales totaled $205.0 million and declined 10%. Excluding foreign currency, sales declined 3%. While sales improved sequentially from the first quarter, year-over-year is largely the result of lower access set revenues.

And finally, anesthesia sales totaled $120.0 million and declined 2%. Excluding foreign currency, sales increased 6%. While sales improved sequentially, growth was impacted by a difficult comparison to last year when global sales increased 27%.

Moving on to Renal, second quarter sales totaled $550.0 million and declined 8% on a reported basis. Adjusting for foreign currency, however, sales increased 4%. U.S. sales were down 1% due to lower HD sales and international sales declined 9% on a reported basis. But excluding foreign currency, international sales were up 4%.

Consistent with our expectations and recent trends, global hema dialysis sales of $96.0 million, declined 19%. Excluding foreign currency, sales declined by 5% due to lower saline and HD product revenues. These results somewhat offset the acceleration in PD sales.

Globally, PD sales totaled $454.0 million and declined 5% on a reported basis. However, excluding foreign currency, global PD sales increased 6% due to consistent PD patient growth, particularly in Latin America, Eastern Europe, China, and the rest of Asia.

Turning to BioScience, BioScience sales totaled approximately $1.4 billion and increased 2%. Excluding foreign currency, BioScience sales increased 13% with notable double-digit growth across most key product categories.

Recombinant sales, $15.0 million, increased 1% on a reported basis and were up 11%, excluding the impact of foreign currency. This is the result of our continued success to differentiate with various dosage forms as well as increase ADVATE conversion in the U.S., which continues to exceed our expectations. In fact, conversion in the U.S. now stands at approximately 70% versus 60% in the second quarter last year.

Turning to the plasma business, we continue to see strong underlying fundamentals and robust growth across our plasma portfolio. Plasma protein sales of $353.0 million increased 21% and excluding the impact of foreign currency, plasma protein sales grew 38%. Performance continues to be driven by strong demand globally across the portfolio for all the proteins, including FIBA, albumin, plasma-derived Factor VIII, and ARALAST.

Antibody therapy sales increased 9% to $344.0 million and excluding foreign currency, antibody therapy sales grew 14%. This growth is a continue result of strong global demand, favorable mix, and pricing.

Sales in the regenerative medicine business totaled $109.0 million and were flat to last year. Growth excluding foreign currency was 9% in the quarter, and finally revenues in the other category totaled $97.0 million versus $162.0 million last year. The decline of $65.0 million was due to lower sales of the FSME vaccine, primarily isolated to the market in Germany, as we discussed earlier.

Turning to the rest of the P&L, and starting with gross margin. Gross margin of 52.4% improved year-over-year by 140 basis points. This margin expansion is primarily due to improved business and product mix, pricing improvements, and manufacturing and cost efficiencies.

In fact, margin expansion across all three businesses more than offset a negative 80 basis point to 90 basis point impact from lower vaccine sales and foreign currency, which resulted from our geographic mix of sales and the related year-over-year change in exchange rates.

Turning to SG&A, SG&A of $660.0 million declined 6% compared to prior year. Excluding foreign currency, SG&A increased in low single digits as we continue to tightly manage general and administrative costs while making appropriate investments in sales and promotional activities to drive future growth. SG&A as a percentage of sales was 21.1%, reflecting a 90 basis point reduction versus the prior year.

R&D spending of $231.0 million increased 4% and excluding foreign currency, R&D grew in low double digits.

As Bob mentioned earlier, we continue to focus on innovation and investments across all three businesses, to advance the pipeline. This encompasses our efforts on bringing to market a new home hema dialysis therapy, increased spending on clinical trials for the evaluation of GAMMAGUARD LIQUID for a number of potential indications, investments in recombinant proteins, vaccines, formulation and delivery technologies, and new therapies that will broaden our regenerative medicine portfolio.

As a result of gross margin expansion and operational leverage, our operating margin of 23.9% reflects an improvement of 40 basis points sequentially and 190 basis points versus the prior year. It is also in line with our full year guidance of 24%, which represents an historic level for the company.

Interest expense was $24.0 million compared to $25.0 million last year and other was $1.0 million of income this quarter compared to an expense of $1.0 million last year as foreign currency translational gains virtually offset miscellaneous expenses. Our tax rate of 18.6% was in line with our guidance and finally, as previously mentioned, EPS of $0.96 increased 13% and exceeded our second quarter guidance of $0.93 to $0.95 per diluted share.

Turning to cash flow, we had another strong quarter. Cash flow from operations totaled $811.0 million and increased 13%, reflecting an improvement of more than $90.0 million compared to last year.

DSO ended the quarter of 53.9 days, which is slightly higher than the first quarter but importantly, DSO was three days lower than the second quarter of last year and continues to track better than our expectations, with no region showing significant increases year-over-year. While we continue to expect this to be the area where we will see the first impact of economic softness, we have not seen any material impact to date.

Inventory turns of 2.3 turns were flat versus the prior period and improved sequentially from 2.1 turns in the first quarter. This was the result of improved performance across BioScience and Medication Delivery offsetting a slight decline in Renal turns.

Capital expenditures for the quarter totaled $216.0 million compared to $207.0 million last year. We continue to expect capital expenditures to total approximately $1.0 billion for the full year as we continue to invest in appropriate capacity across our businesses to support our future growth.

And lastly, to date we have repurchased 16.0 million shares of common stock for approximately $866.0 million. On a net basis, that is net of cash proceeds from option exercises, this amounts to repurchases of 13.0 million shares, or $743.0 million, which is in line with our expectations to repurchase a total of $750.0 million in common stock on a net basis for 2009.

Finally, let me conclude my comments this morning by providing our financial outlook and guidance for 2009 before turning the call back to Bob.

First, as you saw in the press release, we now expect earnings per diluted share of $3.76 to $3.80, and more specifically, we now expect full year sales growth, excluding the impact of foreign currency, of approximately 7% to 8%. And we expect our reported sales growth to be approximately flat to 2008.

By business, excluding foreign currency, we continue to expect full year Renal sales growth of 4% to 5%. We expect Medication Delivery full year sales growth of 5% to 6%, driven by low double-digit growth in anesthesia, high single-digit growth for global injectables, mid single-digit growth of IV therapies, and low single-digit growth in the infusion systems business.

For BioScience we expect sales growth, excluding foreign currency, to be in the 10% to 12% range. This will be driven by high single-digit growth in recombinant sales, high-teens growth in the plasma protein and antibody therapy businesses, and mid-teens growth in regenerative medicine.

We now expect full year sales of the other category, which primarily includes our vaccines business, to decline approximately 20% due to the weak FSME vaccine season we discussed earlier.

I would also like to mention that our 2009 guidance for this category formerly included approximately $60.0 million in annual pandemic revenues related to ongoing advance purchase agreements, or APAs.

Due to the declaration of a global pandemic, our guidance now reflects incremental H1N1 pandemic sales for new government orders that offset revenues previously planned for APAs that have been nullified as a result of the level VI pandemic.

For the full year we expect gross profit as a percentage of sales to improve by more than 150 basis points. We now expect annual R&D growth to be in the mid to high single digits and on a constant currency basis, R&D is expected to increase at double-digit rates.

While we expect SG&A to decline in the low single digits, on a constant currency basis, SG&A is expected to increase in the low to mid single digits.

For the full year we continue to expect our operating margin to improve by approximately 200 basis points versus the prior year, to approximately 24%. We expect interest expense of approximately $100.0 million and other expense to total approximately $40.0 million.

We expect our tax rate to approximate 18.5% to 19.0%, and finally, we expect a full year average share count of approximately 615.0 million shares as a result of our first half share repurchase activities.

From a cash flow perspective, we expect cash flow from operations to exceed $2.6 billion and capital expenditures to total approximately $1.0 billion.

For the third quarter, as we mentioned in our press release, we expect earnings per diluted share of $0.95 to $0.97 and sales growth, excluding the impact of foreign currency, of approximately 7% to 8%. Based on foreign exchange rates, we expect our reported sales growth to be approximately flat in the third quarter.

Thank you. And now let me turn the call back over to Bob for his closing comments.

Robert L. Parkinson, Jr.

Before opening up the call to Q&A I would like to take just a few minutes to provide some additional context on the H1N1 pandemic situation and the potential opportunity which exists for our company.

First, as mentioned several weeks ago, we received the H1N1 strain from the U.S. Centers for Disease Control and Prevention in May. We completed our viral seed bank production and testing and started full-scale production in early June of a pandemic H1N1 vaccine which utilizes our viral-cell culture technology.

I am pleased to announce that we are currently filling and finishing our first batches, and pending final approvals, should be in a position to ship limited quantities of vaccine by the end of this month or early August.

As you probably know, in June the World Health Organization raised the pandemic alert level to Phase VI, indicating a global influenza pandemic involving the 2009 H1N1 strain. This triggered the placement of orders by a number of national public health authorities that held existing advance purchase agreements with Baxter, including the U.K., Ireland, and New Zealand.

To date, we've received orders from five countries for a total of approximately 80.0 million doses. While there continues to be a heightened demand, at this time we're not in a position to take additional orders due to our current commitments and our desire to work with WHO to allocate a portion of the company's commercial production to address global public health issues that are deemed most urgent.

Clearly, we believe this demand has the potential to translate into a significant opportunity for our company. However, at this time it's premature to speculate on the additional financial upside for the remainder of this year, due to several factors.

First of all, the optimization of process yields is proving to be a challenge with H1N1 for all manufacturers, including Baxter. While we don't yet know what our optimum yields can be, we are certain that they will not reach those earlier established with seasonal and H5N1 strains, nor do we know the time it will take to achieve optimum yields.

Once finished product is made available, within several weeks, various regional and national public health authorities require Baxter to conduct clinical trials to confirm dosing and safety as part of initiating wide-spread vaccination programs in their respective countries, particularly in view of the fact that H1N1 virus appears to be less than earlier concerns, which may also impact the future need for product and purchase commitments.

It should be noted that Baxter continues to work with health care authorities on guidelines for clinical testing and final approval of the vaccine.

Also, final dosing regimens, specifically the need for two injections, also need to be confirmed with abbreviated clinical trials. Given these factors, the evolving nature of the global crisis and our continuing internal efforts to optimize yields, our financial guidance for the remainder of the year, as Rob alluded to earlier, conservatively includes only about $30.0 million to $40.0 million of incremental H1N1 revenues.

This is offset by manufacturing scale-up costs, required clinical trials, and high margin revenues related to past advance purchase agreements that have been nullified by current orders.

Therefore, our current 2009 earnings guidance at this time assumes no incremental earnings benefit related to H1N1 demand. As we improve yields and can ship additional orders, we will revise our financial projections as appropriate.

Again, while this is a significant financial opportunity for Baxter, given the aforementioned dynamics, we feel it's premature to get ahead of ourselves with specific financial projections for the last five months of the year. Of course, as the situation continues to evolve, we will do our best to update all of you.

So we are happy to entertain any follow-up questions you may have on that and so let's open up the call now to Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Matt Miksic – Piper Jaffray.

Matt Miksic – Piper Jaffray

Just a follow-up on the vaccine comments that you had, just so I understand this. The 80.0 million doses that have been ordered so far, is it possible that based on yield optimization that the final amount shipped is going to be some number below that or just help me understand the range of outcomes.

Robert L. Parkinson, Jr.

I would say, first of all, clearly having 80.0 million doses ordered is very different than being able to deliver it and in the last five months of the year, for the reasons that I mentioned in my formal comments, obviously we are not going to come close to delivering anything even remotely close to that. All right?

Then as we move into 2010, and I will just tell you it's really premature to make any kind of projections for 2010, clearly we hope to be in a position that in the future we are able to fill the demand of all the orders that we've received. But again, it's premature to speculate on the timing of that. And again, as I mentioned in some of amount of detail, because as we continue to deal with the scale-up issues, additional confirmatory testing that's going to be required when to release product, and so on, it's why we didn't assume any incremental margin for the rest of the year.

Also, recognizing we had to offset the loss of sales and margin for the preexisting APA agreements that were in place.

We certainly hope to over time, in answer to your question, to be in a position to fill all those orders, but clearly that's not going to happen in 2009.

Matt Miksic – Piper Jaffray

Conversion to ADVATE has been an important mix driver but as I understand it the conversion from plasma-derived to recombinant has also been an important trend, outside the U.S. in particular, and I'm wondering one that maybe carries even a more significant positive mix shift as you look at the delta between those two products, in terms of revenues and earnings. It would be helpful if you could talk a little about that and maybe provide some numbers, penetration rates, or understand what's happening around the different markets in the global economy.

Robert L. Parkinson, Jr.

Without getting into some specific rates, let me say this. In most developed markets around the world there continues to be some opportunity to convert from plasma-derived Factor VIII to recombinant forms. A great example would be Japan, which still has a fairly high—I believe it's around 30% of their usage is still in plasma-derived Factor VIII but that is converting fairly rapidly to recombinant forms, which is one of the reasons why our ADVATE is doing so well in Japan.

In other developed markets, Western Europe and the U.S., you know, we're getting in the areas of diminishing returns, I think, in terms of use of plasma-derived Factor VIII and the opportunity to upgrade to recombinant forms. Although there does seem to continue to be some residual buying. Germany is a good example in Europe, which still uses quite a bit of plasma-derived Factor VIII.

I think the real opportunity that you alluded to in your question is what we call rest of world. Okay? And first of all, in emerging developing markets around the world, for the first time hemophilia is being treated to some meaningful degree, obviously with plasma-derived Factor VIII, so the first opportunity is just patients that previously weren't treated are not being treated with plasma-derived as those economies develop and as they allocate more of their national budgets to health care spending.

All of that plasma-derived adoption, of course, represents opportunity longer term to upgrade to recombinant forms, which is why we're re registering products like RECOMBINATE and ADVATE in China and so on. Most usage in China today is plasma-derived Factor VIII and there are many patients in China that aren't being treated.

So those are examples of the long-term opportunity, frankly, that are quite exciting. First of all, adopting plasma-derived Factor VIII and then over time setting the stage for upgrade conversions to recombinant forms.

So the big opportunity is really the rest of the world. There are selective residual opportunities—I mentioned Japan, Germany, and some of the other developed markets—for continued conversion from plasma-derived to recombinant forms.

Matt Miksic – Piper Jaffray

On gross margins, I just want to make sure I'm thinking about the impact of FX here the right way, as you head into the back half of the year. You mentioned a little bit of a negative hit in the quarter. As FX gets better, should we be sort of dialing in some increasing headwind, as FX does have kind of a bit of a negative effect?

Robert M. Davis

As we look to the back half of the year, really, we would expect the currency impact on gross margin percentage to largely be neutral. And really, for the full year it's going to be neutral to slightly positive.

We had a very strong Q1 margin percent contribution from currency. What happened in the second quarter is a little bit of an anomaly given the fact that we had a change in mix of sales to some of the markets, particularly in Easter Europe, with tender activity that went on in the quarter there, that also had the highest percentage impact year-on-year from currency.

But based on where rates are today for all of those markets, everything is improving and I would expect it to be neutral.

Matt Miksic – Piper Jaffray

So the negative impact of FSME also should moderate as well?

Robert M. Davis

It definitely should. There is really virtually no impact of FSME in the back half of the year. It was almost completely in the first half of the year.

Operator

Your next question comes from Bob Hopkins- BAS-ML.

Bob Hopkins- BAS-ML

On the BioScience business, could you just comment as to whether or not those January 1 price increases are sticking and has your outlook changed for pricing in that business relative to the guidance that you've given previously of low- to mid-single digits?

Robert L. Parkinson, Jr.

I don't want to get into specific details on pricing in the plasma or protein business. What I would say is the following: first of all, you saw continued, robust growth of our overall plasma protein business in Q2, including the antibody therapy sector. I would also tell you that our margins for plasma proteins and also antibody therapy improved Q2 versus Q1. They improved in the U.S. as well as O.U.S., so our position consistently has been the outlook for this business continues to be robust. Our position has not changed at all on that, over the recent months, and so we continue to be very confident about the future growth of this business.

That's as about as detailed as I'm going to get on the pricing discussion this morning.

Bob Hopkins- BAS-ML

And there's been some commentary, obviously related to the sales merger in the space relative to some of the comments from the Department of Justice and I was wondering what's your opinion on where that might be headed? At this point do you have any sense as to whether or not the formal look at signaling in the industry or at this point you're not seeing any evidence that that type of investigation might be taking place.

Robert L. Parkinson, Jr.

I have no idea. I mean, obviously, given the merger, the FTC was not only involved with the two companies in question but we've received requests, as did other companies in the industry, as part of that overall assessment by the FTC. But anything above and beyond that, you know, I'm not really going to comment on.

Bob Hopkins- BAS-ML

You obviously had really strong growth in plasma and protein this quarter.

Robert L. Parkinson, Jr.

Right.

Bob Hopkins- BAS-ML

Can you talk to any maybe one-time items that may have contributed to that growth and what specifically was that contribution and where might that go for the rest of the year.

Robert L. Parkinson, Jr.

Actually, we are forecasting continued strength, as I mentioned, for the rest of the year. The business becomes a little bit spiky sometimes based on tenders that may hit in particular quarters. But if you look at the components of the broader category, including FIBA and ARALAST, Albumin, plasma-derived Factor VIII, for some of the reasons I mentioned in my response to Matt's earlier question and so on, frankly, growth in all the subsegments of plasma proteins, including antibody therapy, continue to be very strong.

And so I don't think there was really anything that was inordinate. I know we had a couple of tenders.

Mary Kay Ladone

We did have some tenders that hit in Q2 but I would tell you that even if you excluded those tenders, the growth in the quarter was extremely strong, as far as plasma protein.

Operator

Your next question comes from Benjamin Andrew - William Blair & Company.

Benjamin Andrew - William Blair & Company

Just following up on the plasma topic, you mentioned mix opportunity [inaudible] as one of the drivers here. Where are we on that conversion of the lipolyzed product to liquid in various geographies, just as broadly as you can.

Robert M. Davis

Over all I think we're about 60% converted. It's less outside the United States. Clearly, we're more converted in the United States and really the issue here is going to be as we continue to grow capacity, which is where we made some of our investments, we hope to be able, obviously, to expand that, but right now it's as much driven by capacity constraints, as we look at it.

But to give you kind of the total numbers, liquid—I'm sorry, I was actually speaking to the flexbumin. Liquid is actually over 90% converted, everywhere. Sorry about that.

Mary Kay Ladone

And I would add that we won't be 100% converted until we completely bring up new LA frac, which will be next year.

Robert M. Davis

We've been holding pretty consistent, actually, on the liquid conversion.

Benjamin Andrew - William Blair & Company

PD growth in the quarter, can you broadly characterize, if you exclude the tenders, how much of that is volume versus mix and price. Is it half and half or is it more volume?

Robert L. Parkinson, Jr.

It's virtually all volume.

Benjamin Andrew - William Blair & Company

And can you characterize just roughly what percentage of your company revenues come from the Southern Hemisphere? And I'm curious about the H1N1 trends we're starting to hear out of there relative to some changes in procedure volumes and such, so is that 5% of volume for the company or 10%?

Robert M. Davis

On the first part of your question, the way we've characterized in the past, last year, and it's grown a little bit, roughly a little over $300.0 million has come from the major markets we have in Latin America and those are growing. But that's holding about consistent. That's a full year number.

On your second question, can you repeat it?

Benjamin Andrew - William Blair & Company

Just overall Southern Hemisphere revenues. So Australia is probably one of the bigger markets. South America. I'm just trying to get a rough estimate, North and Southern Hemisphere.

Robert M. Davis

We don't tend to think of our business split that way. I'd have to calculate it.

Benjamin Andrew - William Blair & Company

And have you seen any impact in the Southern Hemisphere because of the outbreak that seems to be picking up speed down there?

Robert M. Davis

Across the rest of Baxter business?

Benjamin Andrew - William Blair & Company

Yes.

Robert M. Davis

No. There's no demonstrable change in our business performance as a result of what's happening in those markets with the pandemic.

Robert L. Parkinson, Jr.

I do think what you're seeing, obviously, is a reinforcement that this truly is a pandemic. You are seeing what's happening in Argentina and Chile and so on. Obviously everybody's anticipating what's going to happen in the Northern Hemisphere this fall and we continue to see countries that, frankly, heretofore we didn't have active dialogue with on pandemic vaccines now initiating contact with us for obvious reasons.

So, who know where this whole thing is going to go. But there continues to be breaking, emerging news on multiple fronts, it seems, every day. But it truly is manifesting itself in a number of the Southern Hemisphere markets, as you mentioned.

Benjamin Andrew - William Blair & Company

Just briefly following on that, as you look at the opportunity, you've got orders for 80.0 million. Is it many, many multiples of that if you had the capacity and say this were to continue into next year, that you might actually be able to serve those sort of orders?

Robert L. Parkinson, Jr.

Well, again, our ability to serve is obviously a function of the yield optimization and so on, so I'm not going to say more than I did in my prepared comments. I mean, the total demand obviously, as you've read the numbers coming out of the U.S. and awards that have been given—basically orders that have been provided to other companies in this space and so on, obviously it's approaching billions.

For reasons we understand. So the issue is, how do we optimize yields, how are we able to produce more doses in our plant and we're confident that there will be demand for whatever we're able to produce over the long term. What we're able to produce over the long term, it's too early to quantify that. It's really that simple.

Operator

Your next question comes from Michael Weinstein - J.P. Morgan.

Michael Weinstein - J.P. Morgan

Let me circle back to the plasma and protein business. You raised guidance for both plasma and proteins and antibody therapy for the year and your prior guidance had been for mid-teens growth and now you're calling for high-teens growth.

Robert L. Parkinson, Jr.

Correct.

Michael Weinstein - J.P. Morgan

Obviously within that, that's probably your strongest comment about your thoughts about the outlook for various markets?

Robert M. Davis

Yes.

Michael Weinstein - J.P. Morgan

The vaccine piece, I did want to focus a bit more on that. So if we look at the announcements that we've had so far from various countries, the U.K., France, Ireland, relative to those contracts, should we think about this a $500.0 million plus opportunity? Is that how we should think about it from a dollar standpoint?

Robert L. Parkinson, Jr.

You know, I don't even want to go there until I know what volumes we can make. I mean, you know what the demand is in terms of the opportunity, for the market. Or at least you can range it. The demand for the market obviously is far in excess of the number that you cited.

It comes down to—and there's been, you know, as you—because I know you follow this closely—over just the last few days we've seen reports that have come out, individuals of the WHO that have been quoted and so on. The industry at large is challenged.

It's not a cell-based or an egg-based thing as much as it is a strained-base phenomenon that is challenging all the manufacturers to scale this up with the kind of productivity that we've experienced on seasonal flu vaccines or, as I mentioned in my comments, H5N1 and so on.

So I think all of us are in the mode of trying to define, as a practical matter, what our real capacity is. And that's the fundamental issue. It clearly isn't the demand.

So trying to put a value on the opportunity is more a by-product of what all the producers can get through their plants, not the demand. As I said earlier.

Michael Weinstein - J.P. Morgan

Right. I was speaking simply to Baxter, given your capacity.

Robert L. Parkinson, Jr.

Again, I don't want to go there. I mentioned in my comments that this is a material opportunity for Baxter. Okay? It's about really when that manifests itself and given, again, some of the unknowns that we're managing through, I don't want to go there. But it's exciting and a material opportunity for our company.

Michael Weinstein - J.P. Morgan

Let me ask you, if we think about this opportunity and what's arisen with the pandemic.

Robert L. Parkinson, Jr.

Right.

Michael Weinstein - J.P. Morgan

It looks like, based on the discussions that we've had with various people, that this could go on for one, two, three years. Most expectations is somewhere around the two to three year period. If you think about the opportunity you're going to have here and the potential revenues and profit that would generate, how do you think about your vaccine business going forward? Do you use this a launching point to get more into the seasonal vaccine business which you're not in at this point?

Robert L. Parkinson, Jr.

A couple of things I would say. Obviously we continue to have our sights set on participating in the seasonal vaccine market in both the U.S. and the rest of the world as an ongoing and hopefully a fairly stable business for Baxter going forward.

On the pandemic front, I'll just give you my view on this. This is more than a one-time event that people will produce products and the need to the market get addressed and then we move on. I think what the world is in the process of recognizing is the threat of pandemic is with us and it will likely stay with us.

As recently as six months ago the focus was H5N1, Avian flu, and all of a sudden here comes H1N1. You know, if you talk to, whether it's our scientists or externally, clearly there's a high degree of concern that the strains are going to continue to evolve and manifest themselves in different ways and it's very possible that the vaccines that are being produced for H1N1 right now will not be effective as the strains mutate and evolve over time.

So I think this pandemic situation is with us and it's here to stay. And how that will manifest itself, I think is difficult to forecast at this point. So I will just tell you how we're looking at this. We're looking at this as more than a one-time short term opportunity. I think you're going to see a sustainable business here.

It may not be as constant as, let's say, the seasonal flu vaccine business is, but it think it will be less intermittent than people thought at one time.

Michael Weinstein - J.P. Morgan

You did announce yesterday that you had completed enrollment in the enhanced Phase III program. I don't want to front run your analyst meeting in September but where does delivery of immunoglobulin rank in terms of your pipeline or your level of enthusiasm?

Robert L. Parkinson, Jr.

We talked about this before. It ranks very high. And I think when I've commented publicly before, if effective, I think this delivery mode potentially could be transformational. You know, the notion of being able to administer IV immunoglobulin subcutaneously instead of intravenously and the convenience or inconvenience that is associated with IV delivery, enabling the patients to self-administer and so on, it's very, very exciting.

Operator

Your next question comes from Frederick Wise - Leerink Swann.

Frederick Wise - Leerink Swann

Injectables up 17%, ex FX, that's the strongest quarter in some time. Can you give us a little more color on what's driving it?

Robert M. Davis

There are a couple of things. We had a government order for Protopen in those numbers, and that's part of it. And then also we took some price increases on a few of our products that flowed through in the quarter as well. And our compounding is another thing that's driving the total number, what we're seeing outside the U.S.

Frederick Wise - Leerink Swann

So last year, [inaudible] grew like 3.5%. Is this combination of things suggestive that the business could grow a little faster going forward?

Robert M. Davis

We're going to see it maybe grow a tad bit faster but clearly this will be the highest quarter, largely due to just the phasing in of the government tender I mentioned, as well as how the price increases flowed through. So this is a little bit of a spike, what you say in Q2.

Frederick Wise - Leerink Swann

On the vaccine op, can you give us—obviously there is a lot of how big can this be and when, but can you give us any color, any ballpark perspective on pricing per unit or margins, relative to Baxter as a whole? Anything, any color would be welcome.

Robert L. Parkinson, Jr.

First of all, we're precluded from our contracts with the various governments in discussing pricing. So I can't go there. And even if I could, to comment on margins openly is a function of throughput and yield. So given where that's at and high variable that is at this point in time, those are additional reason why, frankly, it's really impossible to give you a specific sense in terms of margins. Sorry.

Frederick Wise - Leerink Swann

BioScience margins improved sequentially. Again, any perspective. Can this trend continue and maybe some perspective on what's driving it. Is it the pricing, is it LA frac, is this likely to continue into the second half and 2010.

Robert L. Parkinson, Jr.

Well, yes. I think it's part of our general outlook for the growth of the category, which, again, we consistently describe as robust. I mean, we see the margins not only holding but improving over time, due to a variety of factors. Whether it's product upgrades, whether it's yield improvements, pricing stability and so on.

So we can only say that so many different ways.

Robert M. Davis

This is something obviously in September we'll address as we look at what expectations and the drivers of our margin as a whole, both within in each business, and the total company.

Frederick Wise - Leerink Swann

Just some larger picture overview, two big topics. Health care reform, you're perspective on so far where does it stand relative to Baxter. And maybe some update, just your latest thoughts on acquisitions. More coming, you've done a few. What should we expect.

Robert L. Parkinson, Jr.

Let me try to be fairly brief because each of those individually could be protracted responses I suppose.

It's tough to keep up with what's coming out of Washington and health care reform nowadays, so let me just focus on a couple of basic things.

First of all, in terms of various reform initiatives or proposals coming forward as it relates to underlying demand, again, given the medically necessary nature of our products, that very candidly we don't see anything really fundamentally affecting demand.

The other piece of that, of course, is pricing and reimbursement. The area that you're all familiar with that I think is probably most significant for us has to do with the Medicaid rebates, which of course doesn't apply to Medication Delivery or Renal but does apply to select products to a limited degree within our BioScience business. We'll see where that ends up but as we've addressed before, we believe that we certainly can absorb that.

There are other pieces of reform that are being brought and considered and so on but I guess at this point I'll stop there because until they define themselves more clearly, I don't want to react in terms of what may be or might be at this point.

So we think that in general the implications of health care reform will be certainly manageable by the company, for the reasons we've mentioned previously.

On the M&A front, again, we're opening up the throttle here. There's a number of things that we're looking at. They weren't the biggest deals in the world but I think the SIGMA deal that we announced in the first quarter and more recently the CRRT deal that we did with Edwards more recently, certainly are both indications of adjacencies. Both are kinds of deals that not only are we going to continue to do, I would like to think we will accelerate the pace of that.

So again, our targeting is in those kinds of companies or products that, frankly, are extensions of our core business, not the big megadeals as we've talked about. But I will tell you that we are, as an organization, spending more time now focusing on M&A and BD and we see that as an important opportunity to look for ways to accelerate our growth going forward. So when we do things, we'll announce them.

Operator

Your next question comes from Glenn Novarro - RBC Capital Markets.

Glenn Novarro - RBC Capital Markets

You mentioned that the flu vaccine is going to be a material opportunity and down the road it will be a very profitable opportunity. I'm wondering how this opportunity is starting to change how you view Baxter over a longer period of time. Are there pipeline opportunities now that could get funded that maybe previously couldn't get funded, that drive more share repurchase, that drive an acceleration of plant expansion. So just qualitatively. I know you're probably going to save some of this for September but maybe just share with us how you're thinking about the longer-term opportunities now for Baxter, given this development.

And on currency, based on our analysis, kind of if the dollar stays where it is, it looks like currency for Baxter will be a tailwind come Q4. Is that accurate?

Robert L. Parkinson, Jr.

Let me take a stab at the first question. First of all, I think the flu, both pandemic and the flu vaccine opportunity, both pandemic and seasonal, is more broadly indicative of I think where we're trying to take the company, which is really back to basic science and technology. You know, at the end of the day whatever opportunity is derived on the pandemic program is really a by-product of some wonderfully innovative science or viral-cell technology. Which may have application, by the way, in other areas.

But I think more generally it's indicative of where, at a high level, we'd like the company long term, which is toward more clinically-focused differentiated products that have their roots in science. And again, I won't go through all those in detail. You'll see more discussion of those kinds of things that are in our pipeline when we get together in September.

So I think in some ways what's gone on with the vaccine program is in many ways representative of how the personality of our company is changing and will continue to change over time.

It's also aligned with our continuing ramp up in R&D spending. And again this quarter, on an organic basis, we grew R&D investment at a much faster rate than organic sales growth and so on. And as I've commented before, that's a strategic imperative going forward.

So I think this all ties together conceptually or strategically.

Robert M. Davis

You're correct. Obviously it will depend on the mix of how our sales actually plays out, but it's definitely going to be approaching neutral to potentially a slight positive in the fourth quarter, depending on sales mix.

Glenn Novarro - RBC Capital Markets

Just one quick follow-up. So is it fair to say that this vaccine opportunity does enhance your growth potential?

Robert L. Parkinson, Jr.

Yes. When we had our last investor conference, both pandemic and seasonal flu vaccine were on my famous list of break-through product opportunities that weren't in our base case LRP, so here we are over two years later and the progress we've made on both fronts, seasonal and obviously pandemic, are significant. So as we look out in time, I would think that those are going to be the kind of thing that can accelerate our top line growth over time.

Operator

Your next question comes from David Lewis - Morgan Stanley.

David Lewis - Morgan Stanley

One last question on swine flu here. Isn't it safe to assume that once we got through, let's call it 20% to 25% of production, whatever the pricing happens to be, whatever the market size happens to be, but once you get through 20% to 25% of the production, you would be back to steady state vaccine margins?

Robert L. Parkinson, Jr.

Oh, yes.

David Lewis - Morgan Stanley

And then you've talked a lot about the pipeline here heading into the R&D day. There's a lot of areas where you're ahead of competitors. One area which has been positive for mix has been ADVATE, edited programs slightly ahead of where your programs are on long-acting ADVATE. Does that really reflect setbacks in some of these programs, or merely your belief in the opportunity for pegulated or long-acting ADVATE?

Robert L. Parkinson, Jr.

Obviously this is a space that other companies are focused on that have other programs in various stages of clinical development. As you know, we have our own internal programs, different pathways to develop a next-generation recombinant hemophilia product. Clearly an area of focus for everyone, ourselves and the other players, are extended half-life and less frequent dosing and so on is what I think generally people are identifying as the next-generation advancement in this space.

We continue, obviously, to watch the competitive programs very closely. I would never suggest that theirs were not concerned, but on the other hand I would not suggest that in this race, as we sit here today, we're at a disadvantage at all. Okay? So beyond that I don't really want to get into the specifics of the competitive technologies, where they're at, the timing of their programs, potential risks and so on. I mean, I could do that. We assess that very closely. But it's not appropriate.

David Lewis - Morgan Stanley

Two dynamics in this quarter. You had very strong U.S. plasma proteins and a slightly weaker O.U.S. IVIG, at least versus our model. You're not seeing any emerging market weakness, pricing or volume on the IV front internationally and there is nothing going on in U.S. albumin or broader proteins that drove a very strong quarter?

Robert M. Davis

The answer to both is, frankly, no.

Operator

Your final question comes from Matthew Dodds – Citigroup.

Matthew Dodds – Citigroup

I know you don't want to comment on the pricing for the vaccines, but generally is it a locked in loaded price or do you have some flexibility on the profitability of these contracts, so if it is low initially, you don't get hurt by that based on the contract price.

Robert L. Parkinson, Jr.

No, the contract prices are generally defined when we agree to a stockpile arrangement with governments. And I guess all I would say is we're not going to, for the reasons I mentioned, cite the specific prices. I think there is sufficient latitude to deal with whatever inefficiencies are derived from our manufacturing operations as we scale up to production.

Matthew Dodds – Citigroup

You said on Medication Delivery infusion systems, I think you said this quarter access sets were the weakness, it wasn't pumps. Is that correct, and is that related to the impact [inaudible].

Robert M. Davis

The answer is it is largely access sets and it is—you know, we haven't seen a material erosion of share but we are continuing to see a slight erosion of share and that's impacting the sets.

Matthew Dodds – Citigroup

So that's a continuation trend in the guidance?

Robert M. Davis

Yes.

Matthew Dodds – Citigroup

And then I know it's early but on the subcu IVIG, is there anything we should think about assuming its' successful, on the yields, potentially better yields from that product, tougher yield because of the extra piece. And generally, will that have any impact if you are successful in having a subcu product?

Robert M. Davis

This is not a co-formulated product. It's a kitted product. So the production of IVIG is unrelated to the production of enhanced, and then they're kitted together at the time of delivery, so it's not a production issue with how we do IVIG.

Matthew Dodds – Citigroup

So the advantage here is price, potentially price on the premium product.

Robert M. Davis

Right. Price and share.

Operator

This concludes today’s conference call.

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Source: Baxter International Inc. Q2 2009 Earnings Call Transcript
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