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Executives

Robert Parkinson - Chairman, Chief Executive Officer and President

Robert Hombach - Chief Financial Officer, Corporate Vice President and Treasurer

Mary Ladone - Vice President of Investor Relations

Analysts

Matthew Miksic - Piper Jaffray Companies

Michael Weinstein - JP Morgan Chase & Co

Robert Hopkins

David Lewis - Morgan Stanley

Frederick Wise - Leerink Swann LLC

Lawrence Keusch - Morgan Keegan & Company, Inc.

Bruce Nudell - UBS Investment Bank

Baxter International (BAX) Q2 2010 Earnings Call July 22, 2010 8:30 AM ET

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 Ms. Mary Kay Ladone, Corporate Vice President, Investor Relations at Baxter International. Ms. Ladone, you may begin.

Mary Ladone

Thanks, Sean, and good morning, everyone. Welcome to our Q2 2010 Earnings Conference Call. Joining me today are Bob Parkinson, CEO and Chairman of Baxter International; and Bob Hombach, Chief Financial Officer.

Before we get started, let me remind you that this presentation, including comments regarding our financial outlook, new product development and regulatory matters contain forward-looking statements that involve risks and uncertainties and of course, our actual results could differ materially from our current 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'd like to turn the call over to Bob Parkinson.

Robert Parkinson

Thanks, Mary Kay, and thanks to everyone who are calling in this morning. I'm pleased to announce that our second quarter results that we reported earlier this morning were in line with the guidance that we provided on last quarter's call with adjusted EPS as you saw of $0.93 per share.

On a reported basis, worldwide sales increased 2% for the quarter and on an organic basis, sales were comparable to last year. While Bob Hombach will provide more details on our second quarter financial results and our outlook for the remainder of the year, we're pleased to confirm guidance within the range that we provided to you last quarter, which includes adjusted EPS of $3.93 to $3.98 per share.

While 2010 has been a challenging year for our company, we continue to make progress on a number of fronts. First, as we previously discussed, Baxter and the market more broadly continue to operate through a transition period in the plasma protein market as the macro environment has presented some challenges resulting from high-end employment, the loss of insurance and payers focus on ensuring appropriate utilization.

In addition, over the last few quarters, as we previously mentioned, we've experienced some share loss in GAMMAGARD LIQUID, our premium brand and has implemented new commercial strategies to selectively touch up prices. I'm pleased to report that we're seeing some early positive signs that Baxter share position, as a result of the actions that we've taken, and the U.S. market growth are stabilizing.

As I had mentioned in the past, we remain confident that the Plasma business will be an attractive growth vehicle in the coming years due to the increase in end-user demand resulting from deployment of additional sales resources for those indications that remain under diagnosed and under treated, Baxter's introduction of new and proprietary administration technologies such our HyQ program, expansion of new indications such as MMN and of course, the significant opportunity of a potential Alzheimer's indication.

Second, we continue to fund all key late stage programs and expand the pipeline with select investments in Research & Development as evidenced by a number of recent achievements. Just a few examples, we continue to extend our leadership position in hemophilia, with the initiation of a global Phase I/II clinical trial study in the safety and tolerability of BAX 817 and on-demand recombinant Factor VIIa therapy for patients with hemophilia A or B with an inhibitor.

We commence the Phase I clinical trial for Recombinants Factor IX, a treatment for patients with hemophilia B. The FDA accepted our Biologics License Application or BLA for the subcutaneous delivery of 10% liquid immunoglobulin for patients with primary immune deficiency. The BLA is supported by clinical trial data, which demonstrated efficacy, tolerability and safety of the subcutaneous formulation that were comparable to intravenous therapy.

And finally, we recently received approval in Europe and Canada for the first and only 30-gram dose vial for GAMMAGARD LIQUID. This new dosage form is the most frequently prescribed dose for primary immune deficiency patients and will enhance user convenience. These achievements depicts just a handful of the programs in our pipeline that will present great opportunities for Baxter in the years to come.

Thirdly in the quarter, we were pleased to announce the final details pertaining to the COLLEAGUE Infusion Pump recall in the United States just last week. As we indicated in our press release last week, Baxter will offer replacement, Sigma SPECTRUM infusion pumps or refunds to owners of COLLEAGUE Pumps and will execute the recall over the next two years.

Our primary goal is to support a seamless transition by providing choices that best address the clinical and economic needs of our hospital customers and minimizes disruption to the delivery of patient care. Toward this end, we continue to work with Sigma to increase production capacity of the SPECTRUM pump in order to meet the anticipated demand for this device.

We're pleased to offer closure in definition to our customers, as this has been a very high priority for our company over the last several years. Baxter's a long-standing leader in the infusion pump market and we remain committed to serving patients and hospitals that depend on our products. And as always, I'd be happy to address any further questions you might have on this subject during our Q&A later this morning.

Lastly, I'd like to briefly comment on several management changes that were made during the quarter including the appointment of Ludwig Hantson, the Corporate Vice President and President International. Ludwig joins us from Novartis Pharmaceuticals, where he most recently served as Chief Executive Officer, Pharma, North America and prior to Novartis, Ludwig spent 13 years at Johnson & Johnson. Ludwig is extremely well qualified to lead our international organization and given his significant track record of success and unique breadth of international, commercial and scientific knowledge and expertise, I've also asked Ludwig to lead our corporate business development activities going forward.

In addition, Rob Davis was named the Corporate Vice President and President of Baxter's Renal business. Rob is filling the role vacated by Bruce McGillivray, who's retiring from Baxter after a 30-year career with the company. I think most of you have come to know Rob well during his tenure as Baxter's Chief Financial Officer over the last four years.

And concurrent with this change, Bob Hombach was named Corporate Vice President and Chief Financial Officer. Bob has been with Baxter for over 20 years and has served in a number of finance positions including Vice President of Finance Europe, Vice President of Corporate Planning and Analysis and most recently, as Baxter's Treasurer. Baxter and I are fortunate to have someone with Bob's capabilities and experience to fill this important role.

So now, I'd like to ask Bob to review our second quarter financial results and guidance for the year in more detail, and then I'll come back and provide some additional perspectives at the close. Bob, if you would, please.

Robert Hombach

Thanks, Bob, and good morning, everyone. Let me begin this morning with GAAP earnings, which for the second quarter were $0.90 per diluted share. These results included an after-tax special charge of $22 million or $0.03 per diluted share for the write down of accounts receivable increase associated with an anticipated settlement with the government. As Bob mentioned earlier, excluding the special charge, adjusted earnings per diluted share of $0.93 was in line with our guidance range of $0.90 to $0.93 per share.

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 $3.2 billion in the quarter and increased 2%. Sales, excluding foreign currency, were flat compared to last year. Sales drought in the U.S. was 2%, slightly better than expected due to strong results across Medication Delivery. International sales, on a reported basis, also increased 2% and excluding foreign currency, international sales declined 2%, as the international performance was impacted by soft sales in Europe across several product categories, most notably, lower vaccine revenues.

In terms of individual business performance, beginning with BioScience, global sales in the second quarter totaled approximately $1.4 billion, representing a decline of 4% versus the prior-year period. Excluding foreign exchange, BioScience sales declined 5%. You may recall that the second quarter represents our toughest comparison to prior year across the entire BioScience portfolio as sales drove last year, excluding foreign currency, was 13%.

Within the product categories, recombinant sales of $525 million increased 2% on a reported basis and excluding foreign currency, sales increased 1%. This quarter, recombinant growth benefited from strong ADVATE sales in the U.S., which increased 8%, but were offset by the impact of Healthcare reform and as expected, lower sales related to the finalization of the tender process in U.K. where we received a lower allocation of the award. Excluding these factors, recombinant growth was in the mid-single digits on a constant-currency basis.

Moving on to plasma proteins. Sales in the quarter were $314 million and were down 11%. Excluding the impact of foreign currency, sales declined 12%. Recall that last year, plasma protein sales increased almost 40% on a constant-currency basis creating a very difficult comparison.

As you know, approximately 50% of the Plasma portfolio is comprised of a broader ray of proprietary products including: FEIBA, an inhibitor therapy; ARALAST, a treatment for hereditary emphysema; and FLEXBUMIN, albumin provided in a flexible plastic container. Contributing to the performance in this category, was strong high-teens growth of ARALAST and double-digit growth of FEIBA and albumin outside the U.S. This growth was more than offset by lower sales associated with lost or delayed plasma-derived hemophilia tenders, primarily in Eastern Europe and Latin America and lower albumin sales in the U.S. While we continue to see strong volume growth for albumin in emerging markets such as China, market demand in the U.S. is slowing due to the anemic trend in hospital admissions and surgical procedures.

In antibody therapies, sales of $310 million were down 10% and excluding foreign currency, sales also declined 10%, which was slightly ahead of our expectation. U.S. sales were $211 million, reflecting a decline of 17% versus the prior year. Performance was impacted by a number of factors including a 4.0 impact from healthcare reform, inventory adjustments in the channel, share loss versus last year and the effect of our new commercial strategies to stabilize share.

Outside the U.S., sales of $99 million increased 11% as we continue to see strong volume growth across the regions. This is somewhat offset by pricing pressure particularly in Europe. Sales in Regenerative Medicine, which includes our BioSurgery products totaled $133 million, an increased 22%. Sales excluding foreign currency grew 21% and continue to reflect solid growth of FLOSEAL, COSEAL and TISSEEL and approximately $15 million in incremental sales related to the ApaTech acquisition we completed last quarter.

Finally, revenues in the other category within BioScience were down 22% to $76 million due to declining mice vaccine and advanced purchase agreement revenues and lower-than-expected FSME sales.

In Medication Delivery, sales totaled $1.2 billion, an increase of 9% on a reported basis. Excluding foreign currency, Medication Delivery sales grew 6%. In the U.S., sales were strong and advanced 12% while international sales, facing a tough double-digit growth comp to last year, were flat excluding the impact of foreign currency.

Turning to the product categories. IV therapy sales totaled $418 million in the quarter and grew 9%, driven primarily by 16% growth in the U.S. Excluding foreign currency, sales increased 4%. Performance overall, was due to increased demand for IV solutions and nutritional products, as well as improved pricing.

Global injectable sales advanced 13% to $472 million. Excluding foreign currency, sales grew 10%. Contributing to this performance was strong U.S. pharma partnering sales, growth of select premixed drugs and certain multisource generics. Infusion System sales totaled $216 million and increased 5%. Excluding foreign currency, sales increased 2%. Strong sales of Sigma SPECTRUM pumps more than off set lower COLLEAGUE and access set revenues. And finally, anesthesia sales totaled $130 million and increased 8%. Excluding foreign currency, sales increased 6%, driven by growth of both SUPRANE and Sevoflurane, globally.

Moving on to Renal. Second quarter sales totaled $585 million and increased 6% on a reported basis. Adjusting for foreign currency, sales increased 1%. U.S sales increased 2% and international sales increased 7%. Excluding foreign currency, international sales increased 1%.

Global PD sales totaled $480 million and increased 6% on a reported basis and excluding foreign currency, sales were comparable to the prior year. Global PD patient growth is trending consistently at about 8%, including acceleration in the U.S. where providers and driving conversion to PD in anticipation of the new reimbursement changes that become effective next year.

Internationally, strong patient gains in Latin America and Asia were offset by lower PD growth in revenues in Europe. Hemodialysis sales of $105 million increased 9% as CRRT sales, the Hemofiltration business that we acquired last year offset lower sales at dialyzers in the U.S. Excluding foreign currency, hemodialysis sales increased 5%.

Turning to the rest of the P&L. Gross margin for the company was 51.3% in the second quarter, 110 basis points lower than last year's gross margin of 52.4%. This decline can be attributed to the BioScience business due to reduced higher-margin vaccine sales and cost and efficiencies driven by lower volume throughput in the Plasma and Vaccines businesses. SG&A of $693 million in the quarter increased 5% compared to prior year.

Excluding foreign currency, SG&A increased in low-single digits. While we are aggressively managing general administrative and discretionary spending across the company, we're selectively investing in several key promotional activities aimed at demand creation, new product launches and driving future growth of our higher-margin products.

R&D spending of $219 million declined 5% versus last year due to completed clinical work on late stage programs, lower milestone payments to partners and organizational efficiencies implemented within Medication Delivery. As Bob previously mentioned, we continue to invest in all key programs across the product pipeline.

The adjusted operating margin for the second quarter was 22.7%, a 120 basis points lower than last year, driven by lower gross margin. Interest expense was $25 million compared to $24 million last year, while other expense was $3 million as miscellaneous expenses more than offset foreign currency gains. Our adjusted tax rate was 19.9% for the quarter, a 130 basis points above last year, primarily due to a change in earnings mix between high tax and lower tax jurisdictions. And finally, as previously mentioned, adjusted EPS was $0.93 per diluted share, 3% lower than last year.

Turning to cash flow. Cash flow from operations was strong in the quarter and totaled $783 million. On a year-to-date basis, cash flow from operations totaled approximately $1.1 billion and includes the pension contribution of approximately $300 million that we discussed last quarter. Excluding pension contributions from both years, on a year-to-date basis, cash flow from operations improved by $220 million versus the same period last year. This represents a 19% increase in cash flow. DSO ended the quarter at 54 days, which is slightly higher than last year. The increase is largely due to a modest increase in the U.S. where our DSO is approximately 30 days.

Inventory turns of 2.5 reflect an improvement versus last quarter and last year as we experienced flat or modestly improving turns across all three businesses. Capital expenditures totaled $237 million compared to $260 million last year as we continue to invest in appropriate capacity expansions and other programs across our business to support our future growth.

And lastly, during the second quarter, we repurchased 15.2 million shares of common stock for approximately $677 million. On a net basis, this amounts to repurchases of 13.6 million shares or $616 million. Year-to-date, we've repurchased 22.7 million shares of common stock for $1.1 billion or on a net basis, 17.8 million shares for $911 million, nearly in line with our objective to repurchase $1 billion of common stock on a net basis for the full year 2010.

Finally, let me conclude my comments this morning by providing our financial outlook for the third quarter and update you on our full year 2010 guidance before turning the call back to Bob. First, for the full year 2010, as you saw on the press release, we expect adjusted earnings per diluted share of $3.93 to $3.98. By line item on the P&L and starting with sales, we expect full year sales growth, excluding the impact of foreign currency, of 1% to 3%. Based on current foreign exchange rates and the strengthening of the U.S. dollar, we now expect reported sales growth for 2010 to also be in the 1% to 3% range.

For the full year, we now expect gross margins to decline approximately 100 basis points from the 2009 gross margin rate of 52.4%. As we mentioned last quarter, given our sales and margin profile, we will continue to intensify our focus on managing cost throughout the organization. As a result of these actions and the impact of the strength in the U.S. dollar, we now expect SG&A and R&D growth to be down year-over-year.

We expect interest expense of approximately $100 million and other expense to total approximately $25 million. We continue to expect our tax rate to approximate 19.5%. And finally, we expect the full year average share count of approximately 595 million shares. From a cash flow perspective, we continue to expect to generate cash flow from operations of approximately $2.7 billion.

Now to expand on the full year sales assumptions for each of the three businesses, first, we continue to expect mid-single digit sales growth for Renal and Medication Delivery excluding the impact of foreign currency. Within Medication Delivery, this includes solid growth across the majority of the product portfolio and lower Infusion Systems sales as we execute the COLLEAGUE pump recall and provide SPECTRUM pumps at no cost to our customers. And for BioScience, we continue to expect sales growth, excluding foreign currency, to be flat to down 2%.

By product category, recall that our guidance reflects the impact from of healthcare reform and sales related to the acquisition of ApaTech. For the Recombinant business, we now expect recombinants sales growth for the full year to approximate 4%, similar to growth experienced in the first half of the year, which includes the impact of healthcare reform and the U.K. tender. Excluding these factors, recombinant sales growth is expected to be in line with our long-term growth objective of 6% to 8%, driven once again by double-digit growth of ADVATE.

Second, we continue to expect plasma protein sales to decline in mid-single digits and antibody therapy sales to decline approximately 10%. Third, we expect the regenerative medicine sales growth to exceed 25%, reflecting the ApaTech acquisition and continued low-teens growth in the Base business. And finally, we expect the other category within BioScience to decline approximately 20%, reflecting lower advance purchase agreement revenues and the first half weakness in the Vaccine business.

For the third quarter, as we mentioned in our press release, we expect earnings per diluted share of $0.96 to $0.99 and sales growth, excluding the impact of foreign currency, of 1% to 3%. Based on current foreign change rates, we expect reported sales growth of approximately 0% to 2%.

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

Robert Parkinson

Thanks, Bob. Before we open up the call this morning to Q&A, I'd like to share just a few closing perspectives. While we're pleased that today, we can confirm the earlier sales and earning guidance for the year, clearly, 2010 has been a challenging year. The macroeconomic environment and associated austerity measures taken by many governments around the world, certainly, the impact of U.S. healthcare reform legislation and, of course, the plasma protein market dynamics have all contributed to create headwinds. Having said that, we will still grow both revenue and adjusted EPS in the low-single digits versus 2009.

We are pleased that we now have definition going forward regarding the COLLEAGUE matter, which has been ambiguous for several years now. This is most important for our customers who now have direction and therefore, can the plan accordingly. We'll look for every way, of course, to assist them in that regard. As I mentioned in my earlier comments, we are encouraged that we've seen early signs that we've stemmed the share loss in antibody therapy, and we also see some indications of turnaround in general market growth.

Our balance sheet is very strong, cash generation remains robust. This enables us to both return value to our shareholders while retaining flexibility to pursue business development opportunities that complement our businesses and create shareholder value. Most importantly, our new product pipeline continues to be very exciting, especially as we move closer to significant new product launches. With all of that said, in the recognition of the challenges that we face this year, we remain committed to accelerating earnings growth going forward, albeit at an adjusted base reflecting the dynamics of 2010.

Our diversified business model, our global presence, our emerging new product pipeline and our continued drive to streamline our cost structure will enable us to achieve our long-term objectives. So with that, why don't we open up the call to keep questions.

Question-and-Answer Session

Operator

[Operator Instructions] Rick Wise of Leerink Swann is on the line with a question.

Frederick Wise - Leerink Swann LLC

You talked about on the BioScience side, the U.S. market growth and Baxter shares stabilizing, I think, was the word you used. Can you talk a little bit more, a little more detail about some of the factors you discussed last quarter, and share regaining or stabilizing activities? You talked about touching up price and some other initiatives. Are you past that? Have you achieved the goals and maybe just more broadly, what do you think, given your comments about the plasma down mid-single digits and antibody down 3% for this year, what's the risk of further deterioration?

Robert Parkinson

Several aspects of that, Rick. And as I know, you appreciate I'm a little bit limited in terms of getting too specific for competitive reasons and other reasons. But as we acknowledge and as we had discussions subsequent, I think people recognize that we have, over the last six months, incurred a share loss in the U.S. in the antibody therapy area largely because of the pricing premium that we had established with our GAMMAGARD product. And we experienced some amount of share loss starting probably late last year and certainly into 2010 and as we acknowledged on the last call, we have made a decision to implement what we referred to as pricing touch ups to make sure that we stem the share loss to competition due to lower pricing. And so my comments this morning really speak to the progress, I think, we've made since then. I would tell you we monitor this very closely, really an account-by-account basis, and we're recently confident at this stage that we have, in fact, stopped that share loss as a result of our actions. I would emphasize that in many cases, if not most cases, we still have a somewhat of a price premium with GAMMAGARD LIQUID versus some of the competitive brands just not to the magnitude that had existed at one time where, I think, late last year, got to a point where as maybe 8%, 9% price premium, which were segments of the market and many customers was just too large of a gap to sustain. So we're pleased with the response and the result of that. The last part of your question, in terms of how much further the discount, I mean, look, as I think it's too early to claim total victory here with our efforts. But we are encouraged by the progress that we've made. The other thing is we've also seen some encouraging signs in terms of the general market growth trends overall, in terms of volume growth. So look, it's still early in what we characterize as this transition period in plasma proteins, but it's very appropriate given some of the early signs of success that we've experienced to share those with you this morning and obviously, we're going to keep a high degree of focus on this because the importance of this is for the company.

Frederick Wise - Leerink Swann LLC

Just a separate quick follow-up, you seem to be optimistic or feeling good about the new products in the pipeline over the next 12 months. You talked about moving closer product launches, just in your mind, as we look to some of those new products that could really make a difference, what's top of your mind? Is it on a plasma side? Maybe just go through some of the things you think are most important.

Robert Parkinson

Let me give you some examples and they range, perhaps, from maybe more tactical to more strategic. But first of all, in terms of major new products, or major or large products that we have right now, we're going to be launching ADVATE in Brazil, big market, some time before the end of this year. We anticipate we'll launch ADVATE in Russia next year and China after that. So as we look at the long-term Recombinant business, clearly, emerging developing markets, Rick, we think are significant opportunity as growth in the more established markets begins to slow a bit. We also anticipate a SUPRANE launch in Japan in 2011. So I would start with that in terms of significant products we have today and launches in major geographies over the next 12 to 24 months. In the BioSurgery business, we hope to launch TachoSil shortly. We've received approval for that product. That will be a nice expansion to our BioSurgery portfolio. As I mentioned in my comments, the 30-gram formulation of IVIG was approved in the EU and we will be launching that in the third quarter. We're going to submit in the U.S. in the fourth quarter and hope to have that out in the market in the first half of 2011. The 10% Sub-Q, now this is not with the HYLENEX technology. We anticipate approval in the first half of 2011, so we're excited about that. And then I would say the big ones that are on the famous list, Rick, that I've showed over the last couple of years clearly is the 10% HyQ with the HYLENEX technology. And so we would anticipate we'll have preliminary results of our clinical studies before the end of this year. We'll file them some time in 2011, hopefully earlier than later. And I'm not going to project what the approval cycle will be on that, but we think it will be a clean filing and we're optimistic that, that should be timely approval, so may not get that to the market in 2011, but we're hopeful, certainly no later than early 2012. And that's really in the BioSurgery business. The other business is, of course, with the OLIMEL launches, which is our next-generation nutritional product, which exhibited global very strong growth. In the second quarter, we're rolling that out in a number of European markets as we get approval. And then our Home Hemodialysis technology, we're beginning clinical evaluations some time before the end of this year and we hope to have it launched in a number of markets outside the U.S. next year. So I'll stop there. I can keep going, but those are really the -- those are some of the near-term things that I think are some of the source of our excitement with our new product pipeline.

Operator

Bob Hopkin is on line with a question of Bank of America.

Robert Hopkins

So you mentioned, Bob, that you plan on returning to growth in 2011 off of lower base. I'm just wondering if you can make any comment, do you think that the kind of growth that you can return to is more in line with the long-range plan that you talked about at the last analyst meeting?

Robert Parkinson

That certainly is our aspiration over the LRP. I think the practical question is kind of the rebasing of the dynamics. Obviously, as it relates to healthcare reform, the lion share of that will already be reflected in our actuals for 2010, although as you know, the pharma tax takes place in 2011 and then in 2013 as the follow-on. Device tax, we estimate each of those to be somewhere between $30 million to $40 million, and I think we communicated previously, so those aren't in the base. The bigger issue, of course, is what I call the rebasing of the Plasma Protein business. And as I alluded to in my response to Rick Weiss' question, despite some encouraging signs, I think it's too early to say, okay, this has been totally rebased and then starting to grow. And frankly, until we see a little more visibility on the Global Plasma Protein business, I think we have to be cautious as to the exact timing of -- again, what I would say the rebasing of our business, which we clearly think the lion share of that. We're in the process of incurring that in 2010. But once we get that stabilized, I think, given our diversified healthcare model, geographic reach, opportunities, emerging development markets, the pipeline which continues to be very encouraging, certainly it's our aspiration to get back to a trajectory in line with what we've communicated to all of you previously.

Robert Hopkins

And then just a follow-up question for me is, on the Recombinant side, could you talk about what gives you confidence in getting back to more mid-single-digit type growth in the back half of the year relative to what you saw in the second quarter specifically? And then would you say that December for the IVIG business, is a critical time for you to really gauge the competitive response of what you've done on pricing because that's obviously contracting season. Would you agree that December is the critical month to really gauge the competitive response?

Robert Parkinson

Yes, I think that's fair. Let me start with that and then Mary Kay and Bob can maybe help with your first question on the hemophilia outlook. Yes, I think that's fair. I think there will be more parts played certainly between over the next six months and as you cited, Bob, given the anniversary dates of a lot of these contracts, yes, it will provide more visibility into this question of to what degree has the Antibody Therapy business has been rebased. I think we'll also get more data certainly, an insight as to market growth, turnaround, if any. As I said, we're seeing some encouraging signs of somewhat exhilarating growth of the market. Will that be sustained and if so, to what degree. We'll get a lot more visibility on that over the next six months. So I'd like to be in a position to be more specific today, but I can only tell you what we know and what we see and it's still -- the dynamics are going to continue. But I think year end clearly, they'll be more visibility and this contracting issue you raised is a very practical one. On the hemophilia piece, let me start off and then maybe I'll ask Bob to support with some more facts or Mary Kay. Look, the hemophilia, the Recombinant business in the U.S., Western Europe, market growth is slowing down somewhat. I think the one thing we have going for us in all markets but certainly in the developed markets is, if you look at patients going on therapy, what we refer to as the PUPs, Previously Untreated Patients, in virtually every developed market around the world, our share of that segment with that date is higher than our Recombinant share is in the market overall. And so as those patients grow and given this is dosed on a body weight basis and that's a good, I think, leading indicator that should continue to sustain growth for ADVATE in developed markets. And then of course, emerging developing markets, I cited some approvals and launches in some of the large developing markets with ADVATE. And then, of course, longer term, this is the number one area of priority in terms of our pipeline, our Recombinant Von Willebrand Factor, I mentioned in my prepared comments this morning of initiating clinical trials in both the Factor VII, Factor IX, I wont give too much details. But we have at least three or four different pathways we're investing in, in terms of our next generation longer half-life ADVATE. The hemophilia franchise, to a certain degree the Recombinant franchise, I think continues to be, it looks very good over the long range plan. Having said that, extensive therapy and as governments look to us, sturdy measures, various healthcare reform, initiatives and so on. As we continually commented, this is an area that will be under reimbursement and some pricing pressures selectively. And now, that's in the near term. Because your question was really for the second half of the year, I guess, my comments we're really more longer reaching. Bob, what gives you, some facts you can share.

Robert Hombach

Just to clarify, our guidance is effectively a continuation of the current trends. So we've got it towards approximately 4% growth for the year, which is what we've experienced on a year-to-date basis. The headwinds of healthcare reform and the tender process in the Europe that we've described, those are pretty well defined. And absent those, we continue to see an underlying trend that's consistent with our longer-term expectation.

Operator

Larry Keush is on line with a question of Morgan Keegan.

Lawrence Keusch - Morgan Keegan & Company, Inc.

Bob, not to belittle any of the hard work the organization has been doing on addressing the IVIG issues and controlling the expenses, et cetera. But I'm curious if you can comment on how, you, the senior management team and the Board is really thinking about how you create shareholder value. You're sitting on a lot of cash, you obviously have had some setbacks here, so what can you do? What are the thoughts at the top of the organization?

Robert Parkinson

Yes, on that, and Bob can add on to this after I comment, Larry. Look, in terms of our capital allocation framework, which we've shown you previously. Going forward, we look to continue to operate within that framework, which means returning value to our shareholders in terms of buybacks, in terms of dividend and dividend increases. But we still have latitude to do some things in terms of business development. And it's an area, I've commented previously, I'm spending a lot more of my time, and the Board spending a lot more of its time. And so we continue to be proactive to look for deals that we think truly can create incremental shareholder value. But we're going to be disciplined about that and the easiest thing to do I suppose is given some of the challenges we face in 2010, is maybe to over react a little bit and say, given the strength of our balance sheet, given the latitude that we have there, okay, let's be more proactive on deals. And we may be, but I think that there's always a danger that you lose your discipline and lose your focus and we're going to do everything not to let that happen. The quick answer to your question is really a combination of those things I mentioned in terms of share repurchase, dividends and BD that make sense. Bob, I don't know, if you want to add anything to that. And I think that's probably pretty comprehensive. Is there anything specific within that, Larry, you like me to follow-up on?

Lawrence Keusch - Morgan Keegan & Company, Inc.

Yes, I guess, the two other parts of the question would be, I guess, it wasn't loss on me that you basically completed your share repurchase objectives for the year, we're only at the midpoint of the year. So any thoughts about what you might again utilize that cash for and maybe there's an opportunity at the stock levels to do a little bit above and beyond? And then the other part of that question is do you really need to spend a $1 billion in CapEx?

Robert Hombach

As Bob mentioned, we continue to evaluate how we deploy cash, as you might expect we did accelerate the timing of our share repurchases in the second quarter and made significant progress towards completing our goal for the year. So we look at the back half of the year, evaluate our other investment opportunities, how we might deploy that cash. We'll continue to evaluate whether additional share repurchase makes sense. One thing I would mention that we continually have to balance here is the location of our cash, the majority of our cash is outside the U.S., and as we look at our repatriation plans and the impact that might have on our tax rate, that is an issue we continue to balance as well regarding the timing of our buyback.

Robert Parkinson

On the CapEx piece, I think you can be assured that just like the SG&A spending and R&D spending, given the amount we spent on CapEx, it has been heavily scrutinized this year as well to see, are there things we can defer, other things and so on. But the reality is and you know this, Larry. We're in capital-intensive businesses. The Plasma Protein business is about a capital intensive as in area of healthcare because you've got two significant kind of manufacturing trends, if you will there, both collection of plasma and fractionation. And the IV business, the Peritoneal Dialysis business, these are capital intensive businesses as well. So the majority of our CapEx, as you know, frankly is to support growth going forward and that's a positive story. Another significant piece of it is associated clearly with maintenance of what is a large and complex global manufacturing footprint. But having said that, we're looking at every element of CapEx as well. One piece that's in CapEx, which we haven't talked a lot about is our funding of our ERP [enterprise resource planning] system, which we -- the Board approved last year. Obviously, that has several objectives, most notably to generate process efficiencies in manufacturing and finance, the supply chain and so on, which is an opportunity for continued cost improvement going forward. But that also has been a fairly big element that has been incorporated on our CapEx last year, this year as well. But we're looking at that and we're looking for ways, if we can pare that down, we'll do that.

Operator

Matt Miksic is on line with a question from Piper Jaffray.

Matthew Miksic - Piper Jaffray Companies

One on Plasma, you've stabilized, it sounds like you're on your way to stabilizing your share trends there and I appreciate you sharing that progress. But I guess stepping back, your best guess at market growth, U.S. and o U.S. for IVIG at the moment and maybe some sense of what inning you're in here, Bob, in terms of your touch-up strategy that you've talked about?

Robert Parkinson

But I would say that it's evident that we're being, as I said, successful with the strategy, which we monitor on, really an account-by-account or customer-by-customer basis. So given the way you asked the question, I guess, I'll answer it accordingly. I would say that the middle innings. In terms of market growth, Matt, Bob, Mary Kay, help me out in terms of our latest thinking here.

Mary Ladone

Matt, it's Mary Kay. In terms of just our assumptions from a guidance perspective, we are still assuming low single-digit growth for the year within the market, but I'm sure most of you have seen recent PPTA data, the last two months were encouraging, we were encouraged by that. So early signs, but we haven't come out of our assumption in terms of low single-digit growth for the year, at this point.

Matthew Miksic - Piper Jaffray Companies

And then worldwide?

Mary Ladone

Worldwide, we're seeing strong volume growth outside the U.S., really, across all of the regions. I don't want to quote a market growth from international perspective at this point, Baxter itself is seeing very strong growth from a volume perspective.

Matthew Miksic - Piper Jaffray Companies

So maybe a little better overseas?

Mary Ladone

Correct. It is much better.

Robert Parkinson

It's definitely, better overseas.

Matthew Miksic - Piper Jaffray Companies

One question on COLLEAGUE and again apologies if it's been asked already. A question just from a practical standpoint, how you're approaching this process with your customers? And when along the way will we start to get some confidence that this is going -- some clarity maybe as to which way this is going in terms of your ability to hold share or the potential that you may lose a bit of share, what the process look like and what can we look for?

Robert Parkinson

First of all, it's definitely too early to answer any of those questions. We're too early in the game. We're pleased. I would say by the way, we had a very collaborative process with the FDA, ending with the consent order and specific terms that we communicated last week or the week before, whenever it was. And we're pleased that we have a two-year time period to execute this conversion. And it also provides time to obviously scale up production of the Sigma pumps, which frankly has been underway for some number of months now, but it gives us a little bit more of a runway to do that, but it's too early. I would say maybe six months on, at the end of the year, certainly we'll have a better view of that. We're in the process of pulling together transition guides for our customers, right now. Those will be available before too long and until that's communicated, I think most of the customers right now are kind of sitting on the fence a little bit. So it's too early to answer the specific questions right now, Matt. I think I commented on this last call, if I'm not mistaken. I think that given the advantage of the Sigma pump being able to be used with the standard Baxter sets, as does COLLEAGUE is significant advantage not only economically but in many ways, clinically. And so given the very attractive financial terms, I think of access to the Sigma pump, given the ongoing economics, which is at the lower cost system then the competitive systems that require captive cassettes and given some of the clinical advantages, we have a high confidence level that certainly the vast majority of our customers are going to convert to Sigma. There also is, I'm sure you know some ambiguity in terms of competitive devices and so on in the markets. So as we get the transition guide out to our customers shortly, get response and clearly, like my comment earlier on the pricing, half-life therapy, we'll also be monitoring this on account-by-account basis. So we'll have specific information to be in a position to answer your question more effectively in the future.

Operator

Bruce Nudell of UBS is on line with a question.

Bruce Nudell - UBS Investment Bank

Bob, just turning to your estimate of volume growth for Recombinants in the markets, U.S. and x U.S. And I know Recombinant Factor VIII is a very important product on a profitability basis. How are you thinking about the competitive environment. I'm sure you saw the Biogen IDEC release, that they're going to Phase III. If you can you just comment on volume trends and expectations, U.S., x U.S. and the competitive dynamics, that would be great.

Robert Parkinson

Let me address both parts. First of all, in terms of volume trends, it's a little bit maybe redundant to one of the earlier questions. We see the volume growth in established and developed markets will start to slow down a bit. But our outlook is still in line with what we previously provided to all of you. The opportunity, longer term, clearly is in developing and emerging markets that adopt next generation technology, which is why we're encouraged that we're going to have launches shortly in markets like Brazil, Russia, China and so on. But clearly, this is an area that given how expensive the therapy is and so on, as governments adopt sturdy measures and so on. There's going to be downward pressure in terms of pricing and conversion and so on. But certainly, we still see the recombinant piece of the hemophilia market still growing in line with what we...

Mary Ladone

I'm just going to add. In the Investor Conference in September, we commented that the long-range plan included 6% to 8% growth for Recombinant. That growth was lower in the U.S., so probably, mid-single digits and much higher outside the U.S. And right now, that's what our expectations are still going forward.

Robert Parkinson

So on the second piece of your question, Bruce. Obviously, emerging technologies, next generation products, it's our highest priority from a R&D point of view. Just starting with our own technologies, I mean, over the last couple of years, we have formulated a number of agreements including one on PEGylation technology with Nektar; a deal that we launched or announced with BAX 855 with Lipoxen; an oral product as well this NAS [ph] technology, which we referred to deals that we did a couple of years ago with Flamel Technologies, Duirnium [ph] and so on. We have about five different plays at this to try to get to the next generation technology. Of course, we follow very closely all the competitive developments including the one that you mentioned and we placed that's where we think there's the highest probability of success. I'm not going to comment specifically on competitive technologies, but rest assured that through our tech-assessment processes, we assess all this very diligently, which has led to the array of deals that we've done over the last couple of years. And I think it's fair to say, our highest priority in terms of our R&D efforts is, what's the next generation hemophilia technology. So I'll leave it at that at this point.

Bruce Nudell - UBS Investment Bank

And I guess one follow up not related to IVIG. Looking at PD therapy, I was kind of interested in your commentary that patient growth is 8%, constant currency, revenue growth year-to-date something like 2%. Is there any dynamic there in terms of a tough pricing environment, or should we be thinking about this as patient growth equals revenue growth?

Robert Parkinson

I think there's a -- one dynamic, Bruce, is that the highest growth in terms of patients is in emerging and developing markets, and we get somewhat lower prices. So you have what I'll call a geographic mix effect, which reconciles much of the difference between patient growth and dollar growth. That's probably the biggest factor.

Operator

David Lewis of Morgan Stanley is on the line with a question.

David Lewis - Morgan Stanley

Bob, just first question. Just given your trends in Renal that you saw in the quarter and recent management changes, can you talk about the Renal strategy or specific pressures, whether you're encouraged or less encouraged about the progress you've made in Renal here recently?

Robert Parkinson

Well, I'm encouraged by a number of developments that have not either been implemented, well, have not really been implemented yet. The first is, we would expect almost any day or any week definition on the new composite rate reimbursement in the U.S., which we've commented on previously, which will take effect in January of next year. And without having the specifics at this stage, we know enough about the direction to suggest that the change in the reimbursement methodology in the U.S. clearly will level the playing field economically between hemodialysis and Peritoneal Dialysis. And we believe that, that will be a catalyst for PD growth going forward. We've also seen recently in the U.S. a pick up in our patient growth, probably over the last six to nine months at a level far in excess of what we've experienced over the last five years. So I think that Bruce McGillivray and his team deserve a lot credit for that. I'm confident that Rob [Robert Davis], in his new role will not only carry on, but accelerated that further. The other dynamic of course that we look forward to is to start the clinical trials with our own hemodialysis therapy, which that could be used to much hyperbole here, but I think certainly could be transformational in terms of how patients with end stage renal disease are treated. So that's not an immediate front burner opportunity but as we said earlier, we hope to begin our clinical evaluation of that technology before the end of this year and have product launch sometime in 2011 and primarily in European markets. So those are really the catalyst. The Renal business, of course, has been a slower grower for us over the last few years. We've been patient in this business, waiting for events, whether it's reimbursement in the U.S. or new technologies like home hemo that could be game changers of sorts, and I think we're close to that, so I think. I'm optimistic we're going to be rewarded for our patience in that regard.

David Lewis - Morgan Stanley

The first is, Bob, I know there's a lot of focus on this call and obviously last call on plasma specifically. As you think of sort of your global growth rates across your major franchises, are you still convinced that your existing level of capital spending, your existing level of R&D spending is generating returns that you expected and do you think later on in the year, we could see sort of a redefinition of what you have to spend to generate sort of the new growth rate for the business?

Robert Parkinson

Okay, different elements. R&D and capital. In terms of R&D, as I commented and Bob commented as well on his prepared comments. We have fettered back our R&D spending this year, in view of some of the economic challenges that we have. But, however, I would emphasize a couple of things. We have not fettered back investments in our key programs. And if you look at our list of key programs right now, very few, if anything have fallen off over the last year. I mean, as we've ramped our R&D spending considerably as you know in the company over the last five years, a lot of that has been focused on later stage stuff and so the return are not as quick as perhaps the portfolio of R&D programs might have been in the company, say, five, six, seven years ago. But I think the opportunities are more significant, whether it's any of our new hemophilia investments, new technologies like home hemo, the Alzheimer's program and so on and so forth. So I feel good about the pipeline and what has not fallen out, very little if anything has fallen out and everything largely remains in play. Including things like our seasonal flu vaccines and so on. So as I sit here today, I still feel very good about our pipeline, I feel very good about the prospects, of attractive returns for the investments we've made over the last five years, but also pragmatically in the context of our shorter-term economic challenges. We have gone back. We've pared back a little in terms of release dates, exploratory stuff and we've been more discerning in that regard. So I think it's the right balance of doing that, but not compromising the funding on programs that we think can make a difference. In terms of -- so that's the R&D piece. On the CapEx piece, as I said in an answer to one of the earlier questions, being in the Plasma business is capital intensive. And so it gets down to our ability to support global demands over time and unlike, say, IV production where we have smaller IV plants in numerous countries around the world because of the logistics cost. The Plasma Protein business is very different. Our focus is on just a handful of facilities. Obviously, the best way to increase capacity over time is with new improvements. But the global market growth, we commented earlier on, in response to an earlier question on Antibody Therapy growth in the U.S. versus o U.S. I mean, clearly Antibody Therapy is a double-digit grower in markets outside the U.S. and much faster than that in emerging developing markets. These are therapies that as economies develop, more and more patients are going to get access to these kinds of therapies and there's not a lot of people that can do this and do it well, and I think we do it very well. So it's why we stated earlier, our positive outlook long term about this business. The best bet to play is on new improvements, which is the best way to increase capacity but we're going to have to continue to invest long term in capacity. On the other hand, we're not going to get ahead of ourselves, right? I mean we all know that we have a bit of a conundrum, and what I call a high-class problem, I suppose, if and when we're successful with an Alzheimer's indication, and the ability to support the demand for that. So we're really trying to balance this to the best of our ability. I think you can be assured, we're not going to get ahead of ourselves in installed capacity either in collection or certainly in fractionation that we don't believe it's going to be effectively utilize. On the other hand, we have to take a long view as it relates to a market, which we think is going to be an attractive grower for years to come.

David Lewis - Morgan Stanley

In terms of this quarter, we saw better-than-expected gross margins throughout the better part of the year, should we expect greater SG&A constrainment or cost cutting, or do you think that the second quarter reflects an appropriate SG&A spending level?

Robert Hombach

Yes, we've talked about aggressively looking at our spending and we certainly have implemented processes to get after that. So we do expect the benefits of those actions to accelerate in the back half of the year and drive additional savings in SG&A.

Operator

Our final question comes from Mike Weinstein with JPMorgan.

Michael Weinstein - JP Morgan Chase & Co

Is the Antibody Therapy business in the U.S. was better than you guys were guiding to, and I wanted to understand just what drove that and did you change any of your assumptions relative to the healthcare reform impact on that business. And then the comment Mary Kay, I think you indicated that in the last month or two, you've seen some encouraging data points. I just want you to maybe just highlight what those data points were? Is it the PPTA data or is there's something else you're looking at?

Robert Parkinson

Healthcare reform assumption hasn't really changed from what we communicated, Mike, last quarter. So no change associated with that. And in terms of volume being strong -- it may have been a little stronger than what we anticipated. I think it came in pretty close in terms of our own sales, in terms of what we forecasted, it wasn't that big of...

Mary Ladone

Mike, I would comment that our volumes were sequentially about the same as they were in Q1, which gives us confidence around some of the comments Bob made on seeing early signs of stemming the share loss. In terms of the positive signs, we do see the PPTA data, I know you guys do as well. But we also have our own intelligence in terms of what we're seeing in terms of end-user demand for Baxter products, which we coined as redistribution data. So we have access to that as well, and also gives us some time some confidence and we did see some stabilization and some improvements quite frankly in that regard.

Michael Weinstein - JP Morgan Chase & Co

Do you think you have a broader view beyond the company, the overall health of either the U.S. or overseas markets?

Robert Parkinson

As we commented earlier, we're encouraged by the progress both in terms of sheer retention, some signs as Mary Kay just indicated that the market growth may be picking up a little bit here. That's all good news, but we're going to need some more visibility on this, and I think it's maybe Bob Hopkins that have asked the question earlier, I think likely by the end of the year, clearly we'll have a lot more visibility. So early on, some encouraging signs, we believe our marketing efforts that we described earlier are working effectively, but let's get a few more months under our belt.

Michael Weinstein - JP Morgan Chase & Co

And the infusion pump sales were relatively strong in the U.S., certainly stronger than we were expecting. And your IV therapy sales were also strong. Do you have some added thoughts on that. Infusion pump surprisingly strong in light of what's going on with COLLEAGUE and I know you're trying to get Sigma out there, but it still looks pretty bullish.

Robert Parkinson

We're really in a quarter for infusion system that was really Sigma, which we've been pushing very much obviously with the consent order, those dynamics change. I would say more broadly, Mike, we're clearly encouraged by the ongoing performance of Medication Delivery not to minimize the COLLEAGUE issue, which we will manage through now over the next couple of years, but Medication Delivery, I think consistent with what we've been messaging is accelerating in its growth and fortunately, given some of the challenges in BioScience, we did have strong growth globally in virtually all product categories in Medication Delivery in Q2, particularly in the two strategic categories, which we've commented frequently, which is parenteral nutrition and anesthesia, which are higher margin business. Both of which grew very strong in the second quarter, as well as in the first half of the year. So we have a lot of positive things going on in the Medication Delivery business.

Mary Ladone

Mike, I also just want to add, in terms of Medication Delivery, we did have somewhat of an easy comp in the U.S. compared to last year particularly in the Infusion System business. But to Bob's point, COLLEAGUE did add about $20 million of revenue, I'm sorry, Sigma did add about 20 million of revenue.

Michael Weinstein - JP Morgan Chase & Co

Previously, going back to the September Analyst Meeting, the assumption has been that the company's tax rate regardless of what the government did on U.S. tax reform would migrate higher starting next year and over the course of the next few years, is that still the expectation?

Robert Hombach

Yes, it is. And I think you've seen, it's doing a bit of that this year as well, we're comfortable with the 19.5% assumption for this year, but we would expect something in the 50 basis points range of an increase as we go into 2011, driven primarily by mix of earnings.

Mary Ladone

And Mike, really nothing changed in terms of our long-range plans and what we've had stated last year around the tax rate increase regarding reform in the U.S., if that doesn't happen, then that obviously will be an upside to what we provided in September.

Operator

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

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Source: Baxter International Q2 2010 Earnings Call Transcript
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