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Baxter International Inc. (NYSE:BAX)

Q1 2010 Earnings Call

April 22, 2010 8:30 am ET

Executives

Mary Kay Ladone – VP IR

Bob Parkinson – CEO

Rob Davis - CFO

Analysts

Mike Weinstein - JPMorgan

David Lewis – Morgan Stanley

Rick Wise - Leerink Swann

Bruce Nudell – UBS

Bob Hopkins – Banc of America

Larry Keusch – Morgan Keegan

Matt Miksic – Piper Jaffray

Glen Navarro – Bank of America

Operator

Welcome to Baxter International’s first quarter earnings conference call. (Operator Instructions) I would now like to turn the call over to Miss Mary Kay Ladone, Vice President Investor Relations of Baxter International. Miss Ladone, you may begin.

Mary Kay Ladone

Thank you. Good morning everyone and welcome to our first quarter 2010 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 expectations.

Please refer to today’s press release and our SEC filings for more details concerning factors that could cause actual results to differ materially. In addition, 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 website.

Now I would like to turn the call over to Bob Parkinson.

Bob Parkinson

Thanks Mary Kay, good morning everyone. Thanks for calling in. Our Q1 results we reported earlier this morning were very solid with adjusted EPS of $0.93 per share, an increase of 12% versus Q1 2009 which as you know was in line with our prior guidance.

As you saw, sales increased 11% for the quarter on a reported basis and on an organic basis sales increased 5% which was on the lower end of our guidance. Sales in all of the major businesses and virtually all of the product categories achieved or exceeded expectation with the exception of plasma proteins in the U.S.

On that point let me jump immediately to the obvious news this morning which is our decision to lower guidance for the year from $4.20 to $4.28 to $3.92 to $4.00 per share. While Rob will provide more details in just a few minutes it is clearly appropriate for me to address the basis of our decision to lower guidance at the outset this morning.

There is really primarily two key factors that led us to lowering our outlook for the year. The first of course is the incorporation of our best estimates for the recent healthcare legislation on the company for the remainder of the year. This is largely the impact, and this is primarily in our bio science business, of increased Medicaid Rebates and also the expansion of the 340B program which provides access to Medicaid rebates in the form of discounts to certain providers.

We estimate the total healthcare reform impact for 2010 to be approximately $80 million which is about $0.10 per share. The second factor is really what I would describe as the more protracted and pronounced impact of the transition in the global plasma protein market particularly with emphasis in the U.S. We will clearly discuss this in more detail in the Q&A this morning but what I would like to do is provide some color as it relates to the existing market dynamics, the basis of our projection for the remainder of the year but also our longer-term view regarding this business.

In the short-term it is evident that the market is growing more slowly than our earlier estimates particularly in the U.S. As I commented last quarter we also believe we have lost some unit share, primarily business we gained in late 2008 or early 2009, due to some competitive supply issues. As you know we have not taken prices up this year on Gammagard liquid but it remains the premium brand and is frankly subject to some competitive vulnerability particularly in select segments of the market. So as a result, we have and we will on a targeted basis selectively touch up prices.

While I continue to believe that we and the market more broadly are going through a transitionary period we in retrospect were clearly overly optimistic about the short-term market growth, our ability to retain market share and the near-term impact on the market of deploying additional sales resources for those indications that remain under diagnosed and under-treated. Despite our positive outlook on the growth of our business for the LRP, for the reasons mentioned we felt it was prudent to adjust down our projections for the remainder of 2010.

We do remain confident, as I mentioned, that this business will be an attractive growth vehicle in the coming years. The new and proprietary administration technologies such as our HYQ program which utilizes [inaudible] enhance technology, new indications such as MMN and of course the potential wildcard of an Alzheimer’s indication. We also, as you know, continue to expand sales force and marketing resources around the world to provide an access to patients who have not been diagnosed with primary immune deficiency.

Having said that, in the short-term we must objectively reflect the current market conditions in our forecast for the remainder of the year. As I said, Rob will provide more details later in terms of the forecast assumptions and the financial impact and we will get into more detail in the Q&A but I wanted to get all of this on the table up front this morning.

The other bio science businesses in the first quarter performed well. Recombinants, regenerative medicine, which as you know is our bio surgery business, and vaccines all generated double digit sales growth. We are also encouraged by the accelerating growth in the quarter of medication delivery and the solid growth of renal which I think very much exemplifies the balance of our diversified healthcare model.

Normally at this stage I would highlight a number of our BD and R&D milestones for the quarter. A number of those, by the way, were called out in our press release which we issued this morning but I think in the interest of time and to ensure there is enough time after the end of Rob’s and my closing remarks to make sure there is enough time for Q&A I think I am going to dispense with enumerating all of those this morning.

At this point I will ask Rob to get into some of the specifics of the Q1 results and our revised guidance for the year. Then I am going to come back after that and provide a little broader context and some commentary on our earnings revision. With that, Rob if you would?

Rob Davis

Thanks Bob. Good morning everyone. Let me begin this morning with GAAP earnings which for the quarter were $0.86 per diluted share. These results included a one-time, non-cash special charge of $39 million or $0.07 per diluted share representing a write off of a deferred tax asset resulting from a change in the tax treatment of post-retirement drug benefits under the new U.S. Healthcare reform legislation.

As Bob mentioned earlier, adjusted earnings per diluted share in the quarter excluding the special charge increased 12% to $0.93 and were in line with our guidance of $0.92 to $0.94 per share despite absorbing roughly $0.02 per share impact for increased rebates related to the recently enacted healthcare reform legislation which as you know was not contemplated in our earlier guidance.

Now let me briefly walk you through the P&L by line item before turning to our financial outlook for the remainder of 2010. Starting with sales, worldwide sales totaled $3.14 billion in the first quarter and increased 11%. Sales growth excluding foreign currency was 5% and as Bob mentioned earlier was at the lower end of our guidance primarily due to lower than expected plasma protein and antibody therapy sales. Sales growth in the U.S. was 4%. International sales increased 17%. On a reported basis and excluding foreign currency sales growth was 5%.

In terms of individual business performance let me start with bio science. Global sales in the first quarter totaled approximately $1.4 billion and increased 9%. Excluding foreign currency bio science sales increased 3%. Overall, strong growth in recombinants, regenerative medicine and vaccines offset weak sales of antibody therapies and plasma proteins.

Within the product categories, recombinant sales of $510 million increased 13% on a reported basis and excluding foreign currency sales increased 8% driven by robust growth outside of the U.S. This is the continued result of our efforts to focus on expanding patient access, driving increased diagnosis and increased diagnosis and improving standards of care around the world.

Moving onto plasma proteins, which includes a broad array of products including FEIBA and inhibitor therapy, ARALAST, a treatment for hereditary emphysema, FLEXBUMIN, or albumin provided in a flexible, plastic container as well as plasma dry [factorate] and traditional albumin.

In the first quarter global plasma protein sales were $292 million and increased by 7%. Excluding the impact of foreign currency plasma protein sales declined 1% as lower albumin and PD factor 8 sales more than offset the double digit growth of FEIBA and ARALAST. In the U.S. plasma sales declined 4% as growth of ARALAST, plasma derived Factor 8 and FEIBA were more than offset by lower sales of albumin where we faced a difficult comparison to last year when U.S. albumin growth was approximately 40%. International sales excluding foreign currency were flat to last year as double digit growth of FEIBA offset lower sales of PD Factor 8 and albumin resulting from lost or delayed tenders.

In antibody therapy sales of $322 million were down by 4%. Excluding foreign currency sales declined 7%. As we mentioned last quarter we faced a difficult year-over-year comparison in the first quarter as antibody therapy sales increased by approximately 20% last year. In addition to the difficult comparison, however, sales were lower than our expectations due to a number of factors including somewhat lower market growth, continued inventory adjustments in the channel and continued share erosion.

Sales in the regenerative medicine business which includes our bio surgery products totaled $119 million and increased 20%. Sales excluding foreign currency grew 14% and continue to reflect robust growth of Floseal, Coseal and Tisseel. I would also mention that due to the timing of the closing of the ApaTech acquisition sales of Actifuse were immaterial in the quarter. Finally, revenues in the other category increased by more than 30% to $119 million and included the expected revenues associated with the H1N1 vaccine.

Now turning to medication delivery, we are off to a strong start. First, as we look at the first quarter sales they totaled $1.2 billion, an increase of 14% on a reported basis. Excluding foreign currency medication delivery sales grew 8%.

Turning to the product categories, IV therapy sales totaled $391 million in the quarter and grew 14%. Excluding foreign currency sales increased 6% and were driven by increased demand globally for IV solutions and nutritional products as well as improved pricing. Global injectable sales advanced 22% to $451 million. Excluding foreign currency sales grew 14%. In addition to an easy comparison to last year, growth was driven by increased pharma partnering sales, growth of select pre-mixed drugs and certain multi-source generics as well as double digit growth of our pharmacy compounding business outside of the United States.

Infusion system sales totaled $209 million and increased 5%. Excluding foreign currency sales declined 1%. Strong sales of the Sigma Spectrum pumps were more than offset by lower colleague and access set revenues. Finally, anesthesia sales totaled $127 million and increased 17%. Excluding foreign currency sales increased 11% driven by growth of both Suprane and Sevoflurane.

Moving onto renal, first quarter sales totaled $584 million and increased 13% on a reported basis. Adjusting for foreign currency sales increased 5%. U.S. sales increased 3% and international sales increased 16% on a reported basis. Global hemodialysis sales of $110 million increased 16% and included approximately $15 million of CRRT sales which as you will recall is the hemo filtration business acquired from Edwards in the third quarter of last year. Excluding foreign currency hemodialysis sales increased 5%.

Global PD sales totaled $474 million and increased 13% on a reported basis. Excluding foreign currency global PD sales increased 5% as we continue to see patient gains in the U.S, Latin America and Eastern Europe and double digit growth across Asia. In fact, global PD Patient growth is trending at about 8% and we remain encouraged by the continued acceleration of patient gains in the U.S. resulting from the recent reimbursement changes.

Turning to the rest of the P&L starting with gross margin, gross margin in the first quarter of 51.9% was 80 basis points lower than last year’s first quarter gross margin of 52.7%. All three of our businesses expanded margins in the quarter. However, this expansion was more than offset by three items; first, the impact of healthcare reform which as mentioned earlier totaled approximately $15 million in the quarter. Second, approximately $20 million of write offs related to H1N1 vaccine inventories. Third, the loss of foreign currency hedge gains that benefited last year’s margin by approximately 100 basis points.

Turning to SG&A, SG&A of $683 million in the quarter increased 12%. Excluding foreign currency SG&A increased in mid single digits. R&D spending of $227 million increased 7% and excluding currency R&D grew in the low single digits. Our operating margin was 23% for the first quarter which is 50 basis points lower than last year as a result of the specific items noted earlier which negatively impacted gross margin. Interest expense was $19 million compared to $26 million last year which was principally a result of higher interest income and “other” was an expense of $2 million, similar to last year as miscellaneous expenses more than offset foreign currency gains.

Our adjusted tax rate was 19% for the quarter. Finally, as previously mentioned, adjusted EPS was $0.93 per diluted share, in line with our guidance and an increase of 12%.

Turning to cash flow the year started off quite strong. Cash flow from operations totaled $279 million, an improvement of more than $40 million compared to last year. Excluding pension contributions from both years first quarter cash flow from operations approached $600 million reflecting an improvement of more than $250 million year-over-year. DSO ended the quarter at 53 days which is slightly higher than last year. This increase is entirely due to our mix of receivables outside of the U.S. as our DSO in the U.S. remains under 30 days.

Inventory turns of 2.2 turns improved from 2.1 turns in the first quarter last year, reflecting flat or modestly improving turns across all three businesses. Capital expenditures totaled approximately $230 million compared to $171 million last year as we continue to invest in appropriate capacity expansions across our businesses to support our growth.

Lastly, we repurchased 7.5 million shares of common stock for approximately $435 million. On a net basis, this amount to repurchases of 4.1 million shares or $295 million.

Finally, let me conclude my comments this morning by providing our financial outlook for the second quarter and update you on our revised full-year 2010 guidance before turning the call back to Bob.

First, for the full-year 2010 as you saw in the press release we now expect earnings per diluted share of $3.92 to $4.00 compared to our original guidance of $4.20 to $4.28. As Bob mentioned earlier our revised guidance now includes the impact of U.S. healthcare legislation which is estimated to be approximately $80 million for the full-year 2010 or $0.10 per diluted share.

The majority of this impact is in the Bio Science business and relates to the increase in Medicaid rebates in our hemophilia and plasma businesses as well as new discounts offered to covered entities of the 340B program which under the new legislation is being expanded.

In addition to this impact of healthcare reform our revised guidance also reflects our current outlook for bio science with the major drive being the adjustment to our plasma protein business. Before I walk you through the sales guidance by business let me take a moment to summarize our revised guidance by line item on the P&L.

First, we expect full-year sales growth excluding the impact of foreign currency of 1-3%. The reduction in our sales is primarily the result of the two factors mentioned earlier; healthcare reform and lower sales of plasma proteins. Excluding these factors our sales guidance would have been within our previous guidance range. In addition, based on current foreign exchange rate outlook we expect our full-year reported sales growth of 3-5%. Obviously the foreign currency benefit on the sales will be greater in the first half of 2010 versus the second half of the year.

For the full-year we now expect gross profit as a percentage of sales to decline 100-150 basis points from the 2009 gross margin rate of 52.4% primarily resulting from the specific items noted earlier and the ongoing impact of healthcare reform. Given our sales and margin outlook we will intensify our focus on managing costs throughout the company. Therefore we now expect SG&A and R&D to be flat to 2009 levels. We expect interest expense of approximately $100 million and other expense to total approximately $30-40 million. We expect our tax rate to approximate 19.5% and finally we expect full-year average share count of 600 million shares.

From a cash flow perspective we expect to generate cash flow from operations of approximately $2.7 billion.

Now, to expand on the sales assumptions for each of the three businesses. First, as Bob mentioned earlier we are encouraged by the results in renal and medication delivery and continue to expect both businesses to perform in line with our original sales expectations of mid single digit growth. In Bio Science we now expect sales growth excluding foreign currency to be flat to down 2%. By product category our revised guidance reflects the impact of healthcare reform and additional sales of approximately $60 million related to the acquisition of ApaTech.

For the recombinant business we now expect recombinant sales growth in the 4-5% range. Second, we expect plasma protein sales to decline in mid single digits and antibody therapy sales to decline in the 10-15% range. Third, we expect the regenerative medicine to have sales growth exceeding 25% reflecting the ApaTech acquisition and continued double digit growth in the base business. Finally we expect the “other” category to decline by approximately 5% due to a more conservative outlook of lower advanced purchase revenues now that the H1N1 pandemic has subsided.

For the second quarter as we mentioned in our press release we expect earnings per diluted share of $0.90 to $0.93 and sales growth excluding the impact of foreign currency of zero to 2%. Based on current foreign exchange rates we expect reported sales growth of approximately 3-5%.

Now let me turn the call back over to Bob for his closing comments.

Bob Parkinson

Thanks Rob. First let me say clearly we are disappointed to be in a position to lower our earnings guidance for the year. As we discussed and as we will get into more detail in the Q&A clearly the market realities of the plasma business are what they are. We will talk about that. We have to be realistic and we have to be as objective as possible in providing new guidance for the year.

On the healthcare reform front now that it can be calculated, frankly we reflect it in our base and we move on. So, given the reduction in guidance an obvious I am sure many of you are asking is what is the impact of this revision on our 5-year LRP that we presented as recently as last September’s investor conference. First of all I think you know we didn’t include any impact of healthcare reform in the numbers that we presented this past September; neither the Medicaid rebate, drug and device tax nor on the other hand any impact on demand due to broader coverage which becomes later in the LRP.

So in addition just to give you a little clarity on that, in addition to the $80 million impact that we have now reflected for 2010 there will be some incremental impact in 2011 for the pharma tax and of course the device tax as you know kicks in 2013. Having said that I will tell you the $80 million impact we have reflected for this year represents the lion’s share of the cumulative impact over the 5-year LRP. On that front effectively that impact would need to be overlaid in our numbers as we presented to you last September.

Our revised outlook for the plasma protein business would also need to be adjusted in the LRP. As we said, and you know this business is going to grow nicely for us over the long-term, the short-term base which is really this year and into 2011 will now need to be down adjusted in our 5-year projections. So the real question is how long will it take to re-base for us to feel the effect of various commercial strategies we have implemented and will implement going forward and then of course get back to a position where we are accelerating growth.

That is a question frankly I can’t answer at this point but we hope to be in a better position to provide more definition on that as the year progresses. Before we open it up to Q&A and in closing I will tell you we remain committed to growing our earnings over the long term in line with the rates we did discuss with you last September. To the degree whether the macro business environment is more challenging or the current plasma protein dynamics are more protracted than we have estimated, we will certainly take actions to ensure we create sustained growth and value creation for our shareholders whether that means a different pathway for business development or M&A, a reassessment of our structural costs of our company or whatever other responsible measures are necessary for us to achieve our objectives.

I wanted to be clear on that before we open it up to Q&A. At this point Mary Kay why don’t we do that?

Mary Kay Ladone

Operator, can we open it up for Q&A please?

Question and Answer Session

Operator

(Operator Instructions) The first question comes from the line of Mike Weinstein – JPMorgan.

Mike Weinstein - JPMorgan

Let’s focus on the issue at hand. You have lowered your earnings outlook for the plasma and protein business by $0.18 for the year. That is about $135 million pre-tax and you lowered the plasma forecast to down mid single from having been up mid to high and you lowered the IVIG to down 10-15 from up mid single previously. Can you talk about what you have seen over the course of the quarter within the IVIG and broader plasma protein market that has changed your outlook as meaningfully as it has? Talk about the assumptions you are making over the balance of the year about the changing economics in your business because it is not just a top line reduction. Obviously you are seeing a much greater bottom line impact than what just the top line would represent. If you could go through all of that.

Bob Parkinson

On the last point, that is clearly the big question. We will spend some time talking about that. On the last point in terms of the flow through on profitability clearly as the volume declines this is a business where manufacturing efficiencies, plant utilization both on the collection side as well as on the fractionation side are really critical. As the volumes decline there is an additional leverage impact that translates into margin that I think probably represents a pretty big piece as you try to reconcile the numbers. Let me just address that at the outset.

Let’s take a step back and talk about the market, how we have gotten to this point, what we see going forward. The facts are we miscalled this. Believe me, we have spent a lot of time challenging ourselves asking the question why is that. I think there are several factors that are involved here which are instructive and helpful and then obviously as we not only forecast going forward but as we implement other commercial strategies not only to mitigate the effect of it but to turn it around.

As we look at the market today clearly the market is growing much more slowly than we had anticipated even as recently as pulling together our plan for 2010 and obviously providing the guidance for 2010. Even though in this particular market it is sometimes challenging we have less than perfect market information. It is not like the pharma business where you have IMS data and you can track things in a much more definitive way. It is a little bit elusive. Our best guess is the U.S. market, and let’s just talk about the U.S. market because that is where most of this is centered, it probably is growing no more than 1-2% right now. Okay? So we clearly over called the market growth. I think one of the reasons we did that, if you go back in time, let’s say a year ago, because our year-over-year comps obviously…a year ago right now we were having a very different discussion. Very robust results frankly in excess of what we had projected.

The challenge at that point was how much did we interpret that to be more robust market growth and how much of that was share gains. This isn’t an excuse, it is just giving you the facts and you know most of this. Less than perfect market information. I think we interpreted our strength a year ago in late 2008 and early 2009 to be more a function of more significant market growth as opposed to I think we were gaining more share at that time given the fact that one of our competitors was having some supply issues in the market. I think that is a historical fact that is relevant.

The other thing that was going on in the market in general, as you know, is we were moving over the course of really about two years of being in a fairly dramatic product shortage in the market to then moving more recently of course to adequate supply even leaning to the point where all of us now are adding sales resources and so on, as you know. Then of course mixed in with all of that was the balancing in the distribution channel and ascertain what was fundamental demand and what was really a rebalancing of channel inventory became the third factor.

Just to summarize simply, we over called the market growth. It is growing at a lesser rate. I think there are some environmental factors clearly that are leading to that which I won’t expand on. We can follow-up on that if you like. The market is growing much slower than we had anticipated. As I acknowledged on our last call we have lost some market share. It is largely share I think we gained in late 2008 and early 2009. Since our last call I think we have lost somewhat more market share as well. As you know, we are the premium brand, as I mentioned in my prepared comments.

So we have, we are and we are going to continue to selectively touch up prices where necessary to keep our volume and we are doing that. All at the same time, as you know, we are expanding sales force. That is probably the best I can do in addressing the various dynamics of which there are several and on all fronts we have less than perfect information. Going forward low single digit market growth in the U.S. market. Probably higher growth outside of the U.S. as you know. I really don’t want to get into the pricing discussion for reasons you all understand beyond what I have already commented on.

Going forward of course and the way you change this paradigm in this market is to bring out new products that are differentiated which clearly we are on the path of whether it is our HYQ or new indications or actually 30 gram product we are going to be launching shortly and a sub-q product we hope to launch next year without Hylenex and then the HyQ product with Hylenex and all that. Obviously we wish we had that new product portfolio today. We don’t. But I am glad we have it in place for the future which is the basis of our optimism for this market longer term. I am going to stop there. I covered a lot of things so you can follow-up with any specifics on that.

Mike Weinstein - JPMorgan

So you are assuming some degradation in price. You are assuming some lower throughput to your facilities which is obviously having an impact on the profitability of the business. Help everybody with the question of what turns this business and what turns this market and your view on how you as a management team and how we as investors gain visibility on that.

Bob Parkinson

When you say what turns it in terms of it bottoming out and starting to grow again?

Mike Weinstein - JPMorgan

Exactly.

Bob Parkinson

Well the market growth in the U.S. is as we estimated. The market growth is faster outside of the U.S. Obviously a big question is pricing but for reasons you understand I am not going to comment on that beyond what I have said which is we will touch up prices as necessary to maintain our position. The other event of course that is going on, I think the other thing by the way we probably overestimated was the impact in terms of broadening access and demand creation through bringing our sales force on. That is a little longer-term cause and effect perhaps than what we estimated. I think collectively not only us and the other players in the business are out there doing that. As we know, certainly PID is under-diagnosed, under-served and so to the degree collectively given the fact now the industry has sufficient supply the industry is promoting that.

That becomes an event that also using your phrase turns the market as well. Then of course going forward clearly as our new products track out that becomes a significant variable in the equation of turning it around as well.

Mike Weinstein - JPMorgan

You assumed a lower share count. I assume that means you will be buying back stock?

Bob Parkinson

Yes. It assume we will probably increase the amount of share repurchases we are doing through the back part of the year.

Operator

The next question comes from the line of David Lewis – Morgan Stanley.

David Lewis – Morgan Stanley

Maybe you can just talk about, you mentioned share gain being a sort of predominant driver here. Can you talk about what is implicit in your guidance as it relates to forward looking share loss?

Rob Davis

I don’t think we want to quantify the specifics of what we assume but I will say we do assume we might lose some additional nominal share. Obviously we are going to do everything we can to not have that happen based on the commercial strategy Bob has laid out. Given we have miscalled it the first time we have definitely made sure we have taken a conservative position and built that into our forecast. So hopefully it won’t happen but we are prepared if it does.

David Lewis – Morgan Stanley

In terms of your commercial strategy you mentioned that prior to new innovation other strategies to reverse this share loss it sounds like one would be increased investment but is the only other strategy to offset share loss in the interim price reduction?

Rob Davis

To turn share around without the effect of our sales promotion and without value of the new products in theory that would be the other way to do it. Yes.

David Lewis – Morgan Stanley

In terms of inventory, we have not talked about that here this morning. To what extent did inventories starting at the beginning of 2009 as they progressed through 2009 and here into the first quarter where do you think we are from an inventory perspective? Is this really about end market growth rates or secular growth changes in the U.S. marketplace or do you think it is about an excessive level of inventory in the channel?

Bob Parkinson

I can only speak for us and there is other public data as you know that we all have access to. So I won’t comment on that. It seems to be the inventories in the market are pretty balanced right now and I think given the collective promotional effort, not only us but the other competitors we have inventory levels to a point now we can move forward and promote for new demand creation with a degree of confidence. I certainly wouldn’t characterize the inventories in the market as excessive.

David Lewis – Morgan Stanley

Albumin, it sounds like in general plasma proteins were a little weak. Are you seeing strength in albumin as we have seen in the last few quarters or have we seen any incremental weakening in Albumin either in the U.S. or overseas?

Bob Parkinson

It is kind of a different story. It is weaker in the U.S. and outside of the U.S. it is stronger so kind of mixed messages. There has been demand OUS in markets like China and so on that we and others in the industry have served. To the degree there is weakness in the U.S. obviously we are able to redirect product to emerging and developing markets.

I do think what is interesting on the Albumin question is we have a high percent of our albumin product in the U.S. that is in the Flex container. As we sit here today we are living hand to mouth to keep up with the demand on albumin and Flex container. I guess my point I am making is I think it speaks to the power of differentiated packaging whether it is in albumin or over time in IVIG.

David Lewis – Morgan Stanley

You mentioned ways of creating shareholder value obviously through accrued external M&A. Historically Baxter has been very focused on incremental share buybacks. Actually rather substantial share buybacks. Should we expect that to be less of a focus for the company over the next 6 months or could that be a greater focus of the company in the short-term?

Bob Parkinson

I wouldn’t expect any major change in our historic pattern in terms of share buybacks. I don’t think there is any reason to do that. It still provides us, we still have significant latitude I think to do some things proactively on the BD or M&A front. Rob has taken you through our capital allocation process, if you will. Despite what we have communicated this morning I don’t believe there is any need to deviate from that at all.

Rob Davis

I would just clarify one point there. Long-term we are probably going to do a little bit more this year than we originally had anticipated. To the fundamentals of our strategy is what Bob is speaking to.

Operator

The next question comes from the line of Rick Wise - Leerink Swann.

Rick Wise - Leerink Swann

To what extent, you were over complacent if that is the right word before about some of these changes in the market. Is it possible you are overreacting a little bit now in terms of taking guidance down? It is hard for me to believe you are not being conservative enough. What factors might make this new guidance particularly related to plasma too conservative?

Bob Parkinson

I will be very candid with you. Given the number of moving parts I don’t know we can say we are overly conservative or not. I will just tell you I don’t like lowering guidance. It is the first time I have done it since I have been here and maybe the first quarter I came and since then as you know I have not done it. I don’t want to do it again. So all I can say is we have tried to pull this together in a way so it doesn’t happen again.

Having said that this is a market that has a lot of moving parts. I won’t enumerate and summarize and reiterate all those I took Michael through with his question earlier. I am not going to get put in a corner and say yes this is conservative. We will see. That is the best I can do.

Rick Wise - Leerink Swann

To touch on the other two businesses. Med delivery and PD obviously had good quarters. To what extent can strength there may be offset some of the weaker plasma protein side? You do have a bunch of products launching and are we seeing any kind of market rebound on the capital side of med delivery? Maybe some color there.

Bob Parkinson

Let me touch on a few things and then Rob and Mary Kay can think about this too and add to my comments. First of all the first quarter results in med delivery were very encouraging. Actually very strong. Renal was very solid. I have consistently maintained the diversified healthcare model represents a lot of value in a lot of different ways; scientifically and commercially but also from a portfolio point of view when you have businesses that either slow growth like the pike the plasma situation to be able to offset that. Clearly we are counting on med delivery and renal going forward. When I say going forward I don’t mean in 2010 but over the LRP and we touched on this in the investor conference to pull a greater share of their weight.

On the renal front as you know given some of the legislative changes and composite rate changes which will be put into effect it works in our favor in terms of PD. We have a next generation cycler enterprise which will be launched to the market within a year or so. We are moving forward very positively with what we call Project Pluto which is our own hemodialysis device which as you heard me comment before we think can be potentially transformational in terms of how end stage renal disease is treated. The medication delivery side, the Sigma deal we did last year. The timing of that couldn’t have been better. The product is well received in the market. We clearly have a next generation infusion pump which we hope to get out outside of the U.S. hopefully by the end of this year or early 2011 and then subsequently launch to the U.S. as well.

I don’t want to enumerate all of the other new products in both areas but I think there is a basis of confidence that each of those businesses are going to grow. We also continue I think culturally in each of those businesses because of the margins in those businesses and so on, focus on managing structural cost and so on. We have done a good job of that. I think there is opportunity that remains. Hopefully in terms of driving bottom line profitability in those businesses it can be very helpful to offset for whatever period of time we continue to navigate through some of the plasma challenges. Again, I think it just reaffirms as I said the strength of the diversified model.

Rick Wise - Leerink Swann

This is sort of an unfair question but based on what you know now and it is hard to know exactly where consensus range will average out for 2010 after this morning but is there any reason to think that you can’t still grow EPS double digits in 2011 over 2010? Again based on what you know now?

Bob Parkinson

I am not going to comment on 2011. That is why in my prepared comments I specifically closed the way I did and referenced to what we communicated last September. We remain committed to that over the five years. To the degree the impact of healthcare reform and to the degree the impact in the short-term of the vagaries of the plasma protein business they are what they are and both of those present some holes. We are going to continue to pursue other ways to fill those holes. Sometimes necessity is the mother of invention. So our long-term view continues to be in that range but I am going to stop short of frankly getting hooked in terms of a number for 2011. I know you understand that.

Operator

The next question comes from the line of Bruce Nudell – UBS.

Bruce Nudell – UBS

Historically I think most people on the street have thought that underlying U.S. volume demand for IVIG kind of been in the mid single digit range. First of all, given kind of what you said about the capacity in the market even for you who are best positioned to understand it, do you feel that has been historically actually correct? To the current situation, could you give us your gut impression as to why this volume demand is down at the 1-2% level? Is it because of less intense treatment of patients who are already committed to therapy, saturation of the readily addressable pool; have you reached everybody that has access to care or is it just the ability to recruit new patients as you have historically been able to do is incomplete? How does co-pays and/or insurance kind of phase into that?

Bob Parkinson

Several questions there and I will kind of focus on the same thing. First of all; yes, I think the 5% market growth in the U.S. historically is probably a pretty good number. Then projecting out in time despite my comment on how we assess the market growth right now, let’s say 1-2% in the U.S., we believe going forward the market growth should be every bit as robust as what it has been historically. Say that 5% or 5% plus.

I say that for several different reasons. Again at the risk of being redundant here never in this business have we or the other competitors really amassed sales forces to get out and broaden access through demand creation for a number of indications that continue to be under-diagnosed and under-treated. So all other things remaining equal that should be a positive factor in terms of overall market growth going forward. Then of course all of us in various ways are pursuing approval of new indications and so on. That is independent of kind of the big wildcard of Alzheimer’s. So I think as things normalize out there is no reason to think this market at a minimum shouldn’t grow. The total market growth going forward is at least as the level historically. Okay?

So then that brings you back to the question and you touched on this on what is going on now and why it is [softer]? I think so much of this is a settling out of certainly the macroeconomic environment. Healthcare reform is part of that too I think to some degree as we look going forward. And coverage. I think frankly I am hopeful that a number of our products like hemophilia and antibody therapy and so on, not only the broader coverage going forward but also pre-existing conditions and removal lifetime caps and so on for these expense therapies going forward may very well remove barriers to growth that historically have existed. Clearly that hasn’t been put into play yet.

I think what is going on to a large degree now is we know we have a lot of use that is off-label. IVIG for many specialists is used, I hesitate, it is almost an experimental treatment. It is almost a second line or third line therapy when other treatments are less effective. In a time of more reimbursement pressures and perhaps loss of insurance because of loss of employment and some of those factors, I think that is to a large degree what is going on right now.

As I enumerated at the outset with Mike Weinstein’s question is what did we miss and what did we miscall? One of the things I think we miscalled is to some degree, and it gets to the market growth, was how much of the use of the product to some degree was optional. I think there is more of the market, not a large segment but some of the market is more optional than what we called and that is what is being impacted by the economy.

I will stop there. That is kind of a total [inaudible]. It is probably the best I can do but that is how we see it right now.

Bruce Nudell – UBS

What is the per-patient average co-pay for a year for IVIG? Also is this spilling over to recombinant?

Bob Parkinson

I don’t know that I can answer that. We can get that number. It is highly variable so I don’t know what the average would be. Is it spilling over into recombinant or frankly hemophilia therapy of any kind? Yes, I think these are general market trends that we have commented on before that are going to continue. We know that reimbursement is going to continue to be under pressure and it manifests itself in a lot of different ways which is why for our outlook for hemophilia not only we don’t forecast price increases but actually modest, evolutionary price declines over time.

Operator

The next question comes from the line of Bob Hopkins – Banc of America

Bob Hopkins – Banc of America

To follow-up on Bruce’s question to kind of bottom line it here, you are saying the biggest bucket from a demand perspective is really the macroeconomic environment. That is what you think has had the biggest impact on the marketplace?

Bob Parkinson

To date.

Bob Hopkins – Banc of America

I am curious about your comment in response to Bruce’s question that maybe you underestimated a certain portion of this market is more optional than you thought. Could you provide any more detail there?

Bob Parkinson

I think for per-patient if the specialist gets pushed back from the pharmacist relative to the formulary and the indication and given how expensive the treatment is and that oftentimes depending upon what the condition may be, it truly can be optional in terms of just the clinical intervention. I think oftentimes IVIG is used almost as kind of a last resort type of thing. I think given the expense of it if it is not on formulary for certain indications and there are cost pressures within the provider environment and there is some push back I think to some degree it has an effect on prescribing or utilization.

Rob Davis

I would add the other aspect of this too and I don’t think we think of this as a major driver but it is out there is are we seeing where some patients if they are financially strapped and are worried about financial lifetime caps, obviously that will be fixed in the future, but for now will they extend time in between their dosing. We originally didn’t think that would happen. As late as last year we weren’t getting signals of that in the marketplace or any indications that was going on. But now as we look at it that probably is out there as well. The other aspect of this too is there is a reasonable amount of IVIG units in the hospital. As other procedures are not done, so as you see fewer procedures going on in the hospital it is hard for us to get this because there is not, to Bob’s point, there is not a lot of market intelligence. Just from our anecdotal reaches into the marketplace there does seem to be some correlation that as hospital procedures go down also it will have a knock on effect to the use of IVIG in patients who are in those procedures. So that is another aspect. I think it is a lot of little things, not one big thing that is causing this.

Bob Hopkins – Banc of America

The comments on incremental share loss from the last quarterly call, you quantified share loss in the last quarterly call and gave us the history there which was helpful. Could you talk a little bit about what you are seeing between the last quarter to now in terms of quantifying the incremental share loss between now and then? How much of that is in the neuro indications if you have a sense for teasing that out?

Bob Parkinson

I don’t think we have the granularity to cite it per indication. Actually we don’t have that. I can’t answer that. I think it is probably fair to say cumulatively from the start we have lost probably 2-3 share points.

Bob Hopkins – Banc of America

From the beginning of the year?

Bob Parkinson

Yes. Actually I would say from the start of the fourth quarter of 2009 to be more specific.

Operator

The next question comes from the line of Larry Keusch – Morgan Keegan.

Larry Keusch – Morgan Keegan

Just to make sure I fully get this it sounds like if you look at IVIG you are obviously talking about price. You are obviously talking about demand. But it obviously also sounds like you are saying inventories are not excessive and that does give you some room to pursue some of these under-diagnosed things but it doesn’t sound like you are saying those need to be worked down radically going forward?

Bob Parkinson

No. That is our view.

Larry Keusch – Morgan Keegan

Away from IVIG for a moment, you are sitting on $2.7 billion in cash. You obviously have a very strong balance sheet. I have asked you in the past about your appetite for M&A. Not to say this changes the corporate strategy but again I just want to take a temperature on how you are thinking about it because it certainly seems like there are assets out there.

Bob Parkinson

Simply stated, we are very open minded. Okay? Very receptive. We have processes in place to identify targets. This is a priority for me. Frankly it is a priority for our board. I discuss it with our board at every board meeting. We would like to do some things. We are going to remain disciplined. We are not going to do deals as we have said before for the sake of doing deals. We are well aware of the financial latitude we have to do deals if the right kind of deals come along. So we can’t announce what we are going to do before we do it. All I can do is update you on the process. We are very receptive and frankly I am spending more and more of my time on it and we will see how things unfold.

Larry Keusch – Morgan Keegan

On healthcare reform, again obviously you have talked about the impact on Bio Sciences but what about, again I know the experience is recent, but as you have been out there in your other businesses are you seeing any changes in the way customers are thinking about pricing, pressures or anything you might be seeing away from just Bio Science?

Bob Parkinson

I don’t think pressures that our customers…frankly are a byproduct of just the general economic condition overall and the ongoing challenges specifically as it relates to acute care hospitals. I haven’t seen any change in the hospitals’ behavior given the legislation and the definition associated with that. I think the capital spending continues to be pretty disciplined and reasonably tight in the market. We haven’t seen any major change in that regard. So, to Rob’s point, surgical procedures and surgical procedure growth certainly wouldn’t be characterized as robust that is for sure. So hospital activity generally is fairly [demoralent].

Beyond that, relative to healthcare as I mentioned we are going to obviously get hit by this device tax in 2013. I think a number of you have quantified that and have probably done a pretty good job of quantifying it and about what that is. As I indicated in my prepared comments we have a few products that will be touched by the drug tax starting in 2011. As I said, the $80 million of impact we have reflected in our base for 2010 will represent certainly the significant majority of the cumulative effect of these various things as they cascade out over time.

Operator

The next question comes from the line of Matt Miksic – Piper Jaffray.

Matt Miksic – Piper Jaffray

We have covered a lot of the big issues of the day. I do have one final clarification on it just to make sure I understand it. Obviously this has been a real focus for investors over the last several years. I guess the fear has been this market growth and supply and capacity overshoots demand and drove the market into kind of an oversupply condition similar to what we saw back in 2002 and 2003. I understand some of the near-term trends you talked about last quarter, is what you are seeing in fact more like what happened 6-7 years ago or is this something different?

Bob Parkinson

Mary Kay is the historian in the room having lived through a number of years. It is fair to say I think the conditions right now are very different than what they were 7-8 years ago for a lot of different reasons. These are all things we have discussed with you and you can guess what they are. Seven to eight years ago nobody was out there deploying sales forces to create demand. Baxter wasn’t in a position 7-8 years ago to have frankly an array of new products in this area coming out over time which fundamentally changes the game. The nature of the industry and the number of different capacities is different than what it was 7-8 years ago. I don’t want to expand beyond that. Mary Kay anything you want to add? You are the historian here? It is a great question.

Mary Kay Ladone

Other than some of the dynamics within the industry and the competitive environment and number of players, etc. that we have all discussed many, many times over the years, I think Baxter’s portfolio has really changed over the years. Back then it was really a portfolio consisting of IVIG, PD factory and albumin. I think most of you are aware now we also have a variety of other differentiated specialty products including FEIBA which is really our single largest plasma protein with sales of over $500 million that really is not impacted at all by the dynamics we are seeing today and it is still growing double digits as well as ARALAST which is also growing double digits and is a differentiated product as well.

I think we have seen an evolution in our product portfolio which I think will help us get through this a little bit faster than we probably did back then. We will see what happens.

Matt Miksic – Piper Jaffray

Looking in terms of your other business lines, putting aside the impact you talked about related to healthcare reform, rebates or fees, which products would you point us to over the next 12-18 months as you try to get plasma back on its feet, which products would you point to, to help us offset some of the mix and margin impact of the slower growing plasma business?

Bob Parkinson

Besides the existing growth vehicles of hemophilia and bio surgery and the various product categories of medication delivery like [hemostasia] and nutritionals, if you just look at kind of near-term new product launches in the various businesses, not to get off of IVIG. Let’s start with that. We have a 30 gram IVIG product we hope to get approved this year and hopefully launch in the U.S. by the end of this year. We have a 10% sub-q product without Enhance, without the Hylenex technology that we will be submitting shortly and hope to have on the market in 2011. Then of course HYQ which incorporates the Hylenex technology we are very excited about. Then new indications like MMN and the whole Alzheimer’s thing which we don’t need to get into.

So even within the antibody therapy area we have a very nice lineup of near-term and longer term things that can really I think change the game. The rest of bio science of course we just got approval for TachoSil in our bio surgery business which we will be launching. We continue to make good progress with our seasonal influenza vaccine targeting EU approval this year and hopefully approval and launch in the U.S. before too long.

I guess where we are completing a trial right now for a broader hemostasis claim which could be very helpful for the growth of that product. I mentioned in renal but Enterprise which is the next generation PD cycler we will be launching hopefully by sometime in early 2011. Our hemo next generation infusion pump platform. Then in the short-term a number of market expansion opportunities with existing products. ADVATE launches in big markets this year like Brazil and then next year Russia. Following year China. Supreme launch in Japan. I will stop there. I am getting pretty granular. We have a fairly nice array and continuous array in all of our businesses of new product launches both near-term and obviously some bigger things longer term. In addition to the existing growth platforms whether it is hemophilia or recombinant and bio surgery and so on. I covered a lot.

Operator

The next question comes from the line of Glen Navarro – Bank of America.

Glen Navarro – Bank of America

In a couple of years I think the industry is going to be adding more capacity, at least that is what I have heard from some of your competitors. As we think about the longer term health of the IVIG plasma market, how does added capacity coming into the marketplace over the next couple of years impact your view of your ability to maintain pricing?

Bob Parkinson

First of all, on your question just a thought. I am going to back up to Matt’s question just a minute ago in terms of what is different today. One of the things that is different today is the existing fractionation capacity that exists is not excessive. So to your point some amount of capacity expansion long-term is going to be necessary to meet ongoing demand. Right? Which goes back to Bruce’s question of what do we view longer term market growth to be. Then you get to the dimension of all the companies deploying sales resources which is really a new paradigm focused on broadening access and demand creation.

Then of course one of the questions we frequently get is if you have success with the Alzheimer’s indication my goodness how are you going to have enough capacity to meet that demand? So that is a countervailing factor to your question. What we know, and this isn’t unique to us. It applies I think to all of the companies in the industry that two very expensive capital investment processes that exist in this business; collecting plasma and fractionating. Big capital investment. All of us I am sure are motivated to run our facilities as efficiently as possible. That is one of the reasons getting back to the first question today that Mike asked about the margin flow through on our declining volumes, has a big impact on the plant.

So we are very motivated to run our plants and our operations both collecting plasma and fractionating in a fairly smooth, balanced way because it generates real manufacturing efficiencies. Again, I can’t speak for the other companies but I have to believe it is business 101. They are motivated to do the same thing. There is absolutely no incentive for anybody to build capacity if they are not going to utilize it. That is just bad business.

I think it probably applies to other rational players and you look at this and say why would we get ahead of ourselves? Everybody else is looking at the same dynamics we are right now. Let’s let that play out over time.

Glen Navarro – Bank of America

Plus I think what everyone sometimes misses is the global demand still remains strong even though here in the U.S. it [is slowing].

Bob Parkinson

That is a great point. Particularly on the supply piece in terms of plasma where you have a lot of plasma that is collected in the U.S. and exported to be fractionated or in a fractionated form. This really plays into one of our underlying growth strategies of as you know geographic expansion. Emerging and developing markets. That also becomes another complicating but I think positive characteristic of this whole equation.

Glen Navarro – Bank of America

With currency is the weakening Euro or strengthening dollar having any impact on your bottom line this year?

Rob Davis

For the ranges they have been moving in so far the answer is no. It has not really materially changed. While we have seen what is happening obviously with the Euro that is one of the currencies we have talked about in the past we actually can fairly hedge against. If you look across a lot of the currencies in Latin America and across Asia it is not unilateral weakness you are seeing in those currencies. So it is very specific. It is specific currencies in Europe right now. As we look at where it has been trading, even down to the range that it is even today I think it is coming down below $1.35 we don’t see that changing our outlook at these levels.

Operator

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

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Source: Baxter International Inc. Q1 2010 Earnings Call Transcript
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