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Baxter International Inc. (NYSE:BAX)

Q2 2007 Earnings Call

July 19, 2007 8:30 am ET

Executives

Mary Kay Ladone - VP of IR

Bob Parkinson - Chairman and CEO

Rob Davis - CFO

Analysts

Glenn Reicin - Morgan Stanley

Mike Weinstein - JP Morgan

Larry Keusch - Goldman Sachs

Rick Wise - Bear Sterns

Ben Andrew - William Blair

Glenn Novarro - Banc of America

Dhulsini de Zoysa - Cowen

Presentation

Operator

Good morning, ladies and gentlemen and welcome to Baxter International's Second Quarter Earnings Call. Your lines will be in a listen-only mode until the question-and-answer segment of today's call. (Operator Instructions). As a reminder, this call is being recorded by Baxter and is copyrighted material that cannot be rerecorded or rebroadcast without Baxter's permission. If you have any objections please disconnect at this time.

I would now like to turn the call over to Ms. Mary Kay Ladone, Vice President Investor Relations at Baxter International. Ms. Ladone, you may begin.

Miss Ladone. You may begin.

Mary Kay Ladone

Thanks John. Good morning everyone and welcome to our Q2 2007 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 today includes comments regarding our financial outlook, new product development and regulatory matters and may 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 investor 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. With that I would like to turn the call over to Bob Parkinson.

Bob Parkinson

Thanks Mary Kay. Good morning everyone and thanks for calling in this morning. We are quite pleased with our second quarter financial results, which were reported earlier this morning. Not only do we exceed expectations on virtually all of the key financial metrics, I think more importantly we continue to improve the quality of our earnings and also strengthen our overall financial position. While Rob's going to provide a more detailed explanation of our financial results in just a few minutes. I do want to take a couple of minutes to provide what I think are a few important highlights at the outset of our discussion this morning.

Beyond the obvious, that being EPS exceeding consensus and growing significantly from prior year, I am particularly pleased that sales growth for the quarter after one adjustment for both FX and the TT divestiture grew a very solid 7% and that year-to-date sales growth again adjusting for about FX and the sale of the TT business was 8%.

In fact, if you look back over the last four quarters, our organic revenue growth has approximated 8%. I emphasized this, this morning because as you recall during our March Investor Conference, we did raise what we call our projected base case revenue growth to 7% over our five year long range financial planning period. Given our recent results, I think we're clearly tracking well against that projection while not yet generating any meaningful incremental impact from our wildcard opportunities as well as new business development initiatives.

Another aspect of our Q2 results that I want to highlight upfront this morning is the continuing improvement in the profile of the P&L. Gross margins as you saw improved to 49.2% for the quarter, which is our strongest showing in many, many years. Likewise on an adjusted basis, operating income as a percent to sales achieved 21% for the quarter. And I think the last time that Baxter's operating margin was this high was over five years ago.

The drivers of our improving margin position are what I think you've all come to expect, improving product mix and business mix, and intense focus on pricing opportunities throughout all of Baxter's businesses. Disciplined control of our manufacturing costs and improvement in productivity throughout our global manufacturing footprint, all supported further by the continued pruning of underperforming or lower margin businesses and product lines, of course most notably the recent divestiture of TT business.

The last financial highlight for the quarter, which frankly is really more of a strategic highlight I think, that I want to comment on is our R&D spending. As you saw our strengthening financial position has allowed us to accelerate overall R&D spending, which you know almost a strategic priority for us going forward. Our R&D investments for the quarter increased 21% from Q2 of the prior year and year-to-date 2006 it’s actually up 18% versus last year.

In the vein of R&D, let me take just a minute to update on a few new product clinical and regulatory milestones that were also achieved during the second quarter. First of all, we expanded our R&D capabilities with the acquisition of MAAS Medical, LLC, which is a design firm specializing in infusion systems technologies. MAAS medical brings expertise in technology integration that we believe we’ll create value across a number of our infusion system platforms.

Secondly in the quarter, we initiated clinical trials with our partner Halozyme comparing the safety, tolerability, and the pharmacokinetics of various injectable therapeutic agents administered subcutaneously with and without HYLENEX and also intravenously. As you know, we are very excited about the HYLENEX opportunity and planned a number targeted launches over the next 12 to 24 months.

In addition, in the quarter we achieved a number of milestones in BioScience that I’d like to just quickly summarize. First of all we received FDA approval for the self-manufacturing of ARALAST, our plasma based therapy indicated for chronic augmentation therapy for patients with hereditary emphysema.

We also launched a frozen version of our surgical sealant Tisseel, which is a ready to use version that certainly simplifies the delivery and reconstitution of that product. We also began the manufacturing of albumin and lyophilized IVIG at our new plasma fractionation facility in Los Angeles.

And finally, and we should have released on this earlier in the week or the last week, I think. We received FDA approval for a new 3000 IU dosage form or dosage strength of ADVATE, which we will launch in the U.S. during the third quarter, which further expands our, what is really the broadest line of dosage forms available for recombinant hemophilia products.

Before turning the call over to Rob, I do want to comment on last evening's announcement that was associated with the recall of roughly 4,500 triple channel COLLEAGUE pumps that had been placed earlier as part of our overall COLLEAGUE remediation efforts in the U.S. As I think, you all know in May we received the final go-ahead from the FDA to commence with remediation efforts in the U.S. About six weeks into the remediation program, we identified a processor anomaly in the triple channel devices, and without getting too technical, basically we found that the failure could occur when the software mailbox or what some people refer to as the buffer, which stores data until it can be processed, becomes filled, when users program complex commands. I would emphasize this situation does not occur in single channel devices.

Since we identified this issue we have removed all of the active devices from the marketplace and we have provided customers with alternative pumps. Stating the obvious, this is clearly a disappointment, patient safety as you know continues to be our number one priority and this situation represents another inconvenience to which we subjected a number of our hospital customers, who frankly have been very patient and supportive as we managed through this matter over the last year, year-and-a-half.

Let me take a minute just to share a few facts with all of you regarding the implications of this action and our plans moving forward. As I said the problem we identified is only associated with the upgraded triple channel COLLEAGUE not the upgraded single channel COLLEAGUE. Also as I think you know about three quarters of our installed base of COLLEAGUE's in the United States are single channel and the remediation continues with those devices. Just to give you an update as of this week we have remediated approximately 11,000 single channel devices and these upgrades to the single channel COLLEAGUE's are in fact performing very well in the market.

We've also identified the fix to the triple channel COLLEAGUE issue that I described earlier and we are in the process of testing the change. So then we can report and discuss it with the FDA and then subsequently submit a supplement to the COLLEAGUE Corrective Action Plan. I should also point out that we will be completing all of the work associated with our quality systems. As part of the consent increase so that we can invite in PAREXEL who is the outside expert to evaluate our improvements, and we think we have to be in a position to invite them in before the end of July.

While the situation with the triple channel devices has delayed our time-table somewhat we still believe that we'll be able to complete the remediation efforts in the US consistent with our original time-table. We are also hopeful that we'll receive our certification from Paracel in the timeframe that would allow us to invite the FDA and during the third quarter for their inspection.

As we have previously communicated, we believe it remains prudent not to reflect any sales or earnings associated with re-commercialization of COLLEAGUE in our 2007 guidance at this time. And certainly I had be happy to address any other questions or issues on this matter that you had like to discuss during the Q&A, but not to belabor that, let me now turn the call over to Rob for a more detailed discussion of our Q2 results. Rob?

Rob Davis

Thanks Bob and good morning everyone. I am happy to be here today to discuss our financial results for the second quarter and to provide you with an update on our financial outlook for the rest of the year. As Bob mentioned, we reported strong results today, which favorably compared to the guidance we provided. The quality of our performance is primarily due to solid revenue gains and strong operational performance led by continued gross margin expansion, allowing us the flexibility to selectively invest in sales and marketing programs as well as R&D.

You may have noted that our GAAP results included an after tax charge of $46 million or $0.07 per diluted share. 75% of this charge is cash and primarily relates to the consolidation of certain commercial and manufacturing facilities outside United States, which will yield future costs and operational benefits. Excluding this charge, our adjusted earnings per diluted share were $0.72, an increase of 26%. These results compare favorably to the earnings guidance we previously provided as $0.66 to $0.68 per share.

Turning to some detailed comments about the P&L and starting with sales. Our reported sales totaled $2.8 billion, an increase of 7%. Currency contributed 4 percentage points of growth on the top-line. So, sales growth excluding foreign currency was 3%. As Bob previously mentioned, excluding Transfusion Therapies from both years, reported sales increase 10% and excluding foreign currencies, sales growth were 7%.

Turning to individual business performance, let me start with Medication Delivery, which had sales totaling over $1 billion an increase of 3%. Excluding foreign currency, Medication Delivery sales were flat to the prior year. International sales increased 10% as a result of strong performance in our anesthesia and nutrition businesses, while U.S. sales were slightly below our expectations and were down 3%.

The two main drivers affecting our U.S. performance as we have discussed in the past are the continued decline of Propofol and the expected volatility in our anesthesia business as we transition to a fee-for-service model in the U.S. Adjusting for these factors, U.S. medication delivery sales increased in the low single digits.

By segments, anesthesia sales totaled $96 million in the second quarter and increased 1%. Strong international sales driven by the continued success of SUPRANE and SEVOFLURANE, were offset by decline in the U.S. related to the volatility I referred to you a moment ago.

We are encouraged that underlying fundamentals in this business remain very strong. As reflected by the solid end-user demand we've seen year-to-date. With our first half anesthesia sales totaling $185 million an increase of 24%, we are comfortable that our full year sales will increase in line with our expectation of more than 25%.

The global injectables business generated sales of $381 million and increased 1%. Strong growth in our pharma partnering business, which was up by more than 30% partially offset the decline in generic injectables and Propofol.

IV Therapy sales were $346 million and increased 7% with currency contributing five points to growth. Solid international sales driven by the nutrition franchise were offset by a modest decline in U.S. sales, given a tough comparison to last year, when sales increased by 10%.

Infusion system sales totaled $208 million and were similar to the first quarter. Growth in U.S. of 3% is in line with overall market growth. International sales were flat to the prior year, due to the initiation of commercial sales outside the United States in the second quarter of 2006. As of now, we have met the pent up international demand for COLLEAGUE pumps. Therefore, as we return to more normalized growth outside the United Sates, we will face difficult comparisons through the second quarter of next year.

In summary, while we faced competition on our multi source generic business and deal with the tough comparisons for Propofol and COLLEAGUE outside United States. We continued to be encouraged by a number of positive trends across our Medication Delivery business, including the solid fundamentals in our IV therapy and anesthesia businesses and the growth prospects in pharma partnering. As a result, we continue to expect Medication Delivery to contribute sales growth excluding the impact of foreign exchange in the 4% to 6% range for the full year.

Moving now to Renal, second quarter sales totaled $553 million, an increase 7%. Excluding foreign currency, sales growth was 3%. Global PD sales increased 9%, with currency contributing four points of growth. This performance is once again the result of strong international growth given accelerating patient gains, particularly in China, the rest of Asia, Central and Eastern Europe, and Latin America.

In the U.S. while PD patient growth was up in the low single digits, sales were flat, as one of our larger customers exceeded their contract threshold number of patients through giving more attractive pricing. And finally, in Hemodialysis, reported sales increased modestly, but were down year-over-year excluding the impact of foreign exchange, due to lower sales of dialysers.

In summary, excluding the impact of foreign currency, we continue to expect 4% to 5% sales growth in Renal for the full year. The success of our back to basics approach is strengthening our global leadership position and we will continue to expand our presence geographically.

BioScience reported another outstanding quarter over sales of $1.2 billion, an increase of 20%. This growth includes five percentage points of benefit from foreign currency and excluding this benefit sales growth in Bioscience was 15%.

Recombinant sales of $431 million increased 9% with strong international growth of 17% and 2% growth in the U.S. U.S. growth rate was affected by last year's initial orders of our ultrahigh potency 2000 IU dosage form of ADVATE, which totaled approximately $15 million. We continue to see accelerated conversion to ADVATE with ADVATE sales now comprising almost 70% of our total recombinant sales.

Conversion in Europe remains over 90% and we've now converted just over 50% of our patients to ADVATE in the United States. We continue to expect ADVATE sales to exceed $1.1 billion in 2007 driven by continue demand and recent market launches.

Turning to the plasma business, sales of $243 million increased 14%. Contributing to this performance there is accelerated volume growth of FEIBA, our Factor VIII inhibitor therapy, the continued success of our FLEXBUMIN launch and improved Albumin pricing, as well as growth of ARALAST.

Antibody therapy sales increased 20% and total $238 million driven by continued conversion to the premium priced liquid Gammagard, as well as price improvements in the U.S. and in Europe. Sales of our regenerative medicine business increased 10% driven by strong international growth. Finally, revenues in the other category totaled $191 million and increased by more than $80 million year-over-year, primarily due to the better than expected growth in vaccines.

As we discussed last quarter a one winner in Germany and changes to vaccination recommendation by the government drove increased demand for FSME, encephalitis and meningitis C vaccines. Vaccines sales totaled more than $100 million in the quarter, an increase by approximately $50 million year-over-year.

Recall, that while we have generated revenues of approximately $350 million in the other category during the first half of this year, this performance was due to vaccines seasonality from one-time H5N1 stockpile shipment in the first quarter and other unique factors that we described.

Sales in the other category in the second half of the year will be down compared to the prior years as we complete the planned transition of marketing rights for BeneFIX back to Wyeth and vaccine growth is more normalized.

Clearly BioScience has reported excellent results in the first half of 2007. Given strong average conversion, we continue to expect recombinant sales growth in the high single digits with fully year ADVATE sales exceeding $1.1 billion. We expect plasma proteins to grow in high single digits and antibody therapy sales to total more than $900 million.

Regenerative medicine sales will grow in low to mid single digits for the full year. We now expect total BioScience sales excluding the impact of foreign currency to increase 11% to 13% for the full year and sales comparisons in the back half of the year will continue to get more difficult as we absorb the loss benefits sales in Europe, which totaled $90 million in the second half of last year and as vaccines return to more normal sales levels.

I’d like to make one other clarification. Regenerative medicine sales will grow into low to mid teens for the year. I apologize for that misstatement.

Turning now to the gross margin, gross margin in the quarter were 49.2% that improved sequentially by 1.9 points, as result of higher gross margins in each of our businesses. Gross margin also improved 2.7 points versus last year’s gross margin of 46.5%, primarily due to improved business and product mix. In the second quarter, SG&A of $621 million was flat to prior year as a percent of sales and increased 7%. This increase is due to continued investments in select marketing programs across the portfolio. Benefits derived from the Transfusion Therapy divestiture were more than offset by foreign exchange and increased stock compensation expense.

R&D spending of $177 million includes an $11 million write-off of in-process R&D for the MAAS Medical acquisition, Bob mentioned earlier. Excluding this write-off, R&D increased 14% with double-digit increases across all three businesses. Our operating margin in the quarter was 21%, an improvement of 2 percentage points, even after increases in SG&A and R&D.

Other expense of $17 million was similar to last year, while interest income of $1 million compares to interest expense of $10 million last year, due to higher interest rates and a building cash balance.

Our tax-rate in the quarter was 17.5%, which is lower than our original expectation due in part to a settlement of an international tax audit, accounting for approximately 1% of EPS benefit. In addition, as we’ve discussed last quarter, we were granted an extension of tax incentives in one of our favorable jurisdictions outside the United States, a portion of which is reflected as one-time adjustment to our rate. Including these items, our operational tax rate was approximately 20% and inline with our expectations.

Finally, earnings per diluted share of 72% increased 26% compared to adjusted EPS of $0.57 last year. Moving now to cash flow, cash flow from operations for the quarter totaled $731 million and improved by almost $200 million, compared to $543 million in the Q2 last year. Year-to-date, cash flow from operations was $946 million, and improved by approximately $100 million versus last year.

Inventory terms of 2.6 terms are slightly lower than 2.7 terms a year ago. This is primarily due to the continued inventory build in Medication Delivery for the COLLEAGUE remediation efforts.

DSO, at 56 days is higher than last year, primarily due to a shift in our geographic mix of sales, partially offset by lower DSOs in the United States.

In the second quarter, we repurchased $544 million of common stock or almost 10 million shares. Year-to-date, we have repurchased $814 million for 15 million shares, and we remain committed to returning value to our shareholders, with continued share repurchases and our quarterly dividend. In fact, we expect to continue on pace with our program and repurchase at least $1.5 billion of stock during 2007.

Finally, let me conclude my comments this morning by providing our revised outlook for the full year of 2007. As you saw in the press release this morning, given our strong Q2 results, we now expect earnings of $2.65 to $2.70 per diluted share. For the full year, we continue to expect sales excluding the impact of foreign currency to increase in the 4% to 5% range and at current rates, we now would expect currency to contribute approximately two percentage points of growth for the full year.

Our sales guidance includes a $120 million in sales reductions in the second half of the year, related to benefits and the transitional Propofol back to Teva, as well as the impact of the transfusion therapy divestiture. Revenues related to the transition services provided to the transfusion therapies business are now expected to total more than $200 million for the full year. As we previously communicated adjusting for foreign currency and transfusion therapies in both years our full year organic sales growth would approximate 8%.

We continue to expect gross profit as a percentage of sales to improve by more than 200 basis points and operating margin to improve by more than a 150 basis points. We now expect interest and other expense combined total less than $70 million. With interest expense trending higher in the second half as we address a portion of the net investment hedges that would otherwise expire in 2009 before the end of this year.

For the full year we now expect our tax rate to be approximately 20% and we expect our full year average share count to be approximately 660 million shares. And lastly we continue to expect cash flow from operations to total approximately $2.3 billion and capital expenditures to total approximately [$700] million.

For the third quarter, we expect earnings per diluted shares of $0.64 to $0.66 and sales growth excluding the impact of foreign currency up 3% to 4%. In summary we are very pleased with our operational performance due the first half of the year. We've generated solid revenue growth consistent with our long range expectations and are proud of the improved profile of the P&L as Bob mentioned.

As we stated in the past our focus on gross margin expansion affords us the opportunity to accelerate investments to grow our business for the longer-term, while at the same time allowing us to meet or exceed our shorter term EPS objectives. This is best evidenced by our accelerated growth in R&D year-to-date and the significant growth we've achieved in earnings per share. These results validate the strength of our diversified healthcare model and also reinforce our confidence in our future prospects. Thanks for your attention and at this point, I would like to open the call up for Q&A.

Question-and-Answer Session

Operator

Thank you, we will now begin the question-and-answer session. (Operator Instructions). I would like to remind participants that this call is being recorded and a digital replay will be available on the Baxter International website for 30 days at www.baxter.com. Our first question comes from Glenn Reicin with Morgan Stanley.

Glenn Reicin - Morgan Stanley

Good morning, folks.

Bob Parkinson

Good morning.

Rob Davis

Good morning.

Glenn Reicin - Morgan Stanley

Just a couple of straightforward questions here. Number one, on the share repurchases, the 1.5 billion is that a gross number or a net number.

Rob Davis

It’s a gross number.

Glenn Reicin - Morgan Stanley

Okay. And what do you think the net is?

Rob Davis

Right now it's probably about 1.1, 1.2.

Glenn Reicin - Morgan Stanley

Okay. And then, can you talk a little bit about the restructuring program and also talk a little bit about the mechanics of what's happening in anesthesia, and why that's going to change in the back half of the year?

Bob Parkinson

Sure. With the restructuring program obviously, until we had the opportunity to basically inform all of the individuals inside and make some final decisions, I don’t want to get too specific. But basically, what we're looking at is rationalizing some of our manufacturing and commercial footprints mainly in Europe, which is largely the result of legacy business development deals that are done in the past. And we're just taking the opportunity to clean some of that up and improve our efficiencies and how we operate. And that's the largest portion of it. If you look at the breakdown of the total charge after tax, it was about $45 million on a pre-tax basis it's about $70 million and that’s made up mainly of severance with a lesser amount for asset write-offs. So that’s the program. It will be executed over the next couple of years; we would expect to see about $0.02 of improvements going forward, but we would probably not going to reach that full benefit until end of ‘08 or early 2009. So it’s out of a little way, but clearly we felt that was the right move, that continues our efforts to improve our operational efficiency and is just another step as we look to make sure we have the optimum portfolio, both in terms of the mix and how we structure it.

Glenn Reicin - Morgan Stanley

These are medication delivery, as always?

Rob Davis

Yeah, this is all medication delivery and renal operations. There are some small admen in bio, but there is no manufacturing involved in BioScience.

Glenn Reicin - Morgan Stanley

Got it. Okay and then the anesthesia -- can you just explain how this whole model works and why would it impact this quarter sales, but not future sales?

Rob Davis

Yeah, what we are looking at is, I think we’ve signaled as early as the fourth quarter of last year, we started to see our stock-in positions in the wholesaler channel change both as the wholesaler anticipated us moving to this fee-for-service model. And then moving to the first quarter, you’ll recall we actually had, I think it was 68% growth in the U.S. and which was again the stocking effect, but as we move through the rest of the year, I think you can, you will see this next year this should be totally out, because what we are watching really now is for wholesalers to get to what would be a normalized expected stocking level, which is about 30 days. They are not completely there yet, but that’s really what’s driven it, and that will be out of our volatility, out of our comparisons as we move into next year.

Glenn Reicin - Morgan Stanley

This has nothing to do with changes in the way you build your customers for these products?

Rob Davis

No, and if you look-- and I highlighted in my comments end-user demand -- because that’s really what we look to try to look and exclude this noise created by the stock and volatility, we continue to see very strong end-user demand in the United States. It's growing as expected and it's very consistent. So that tells us this is a stocking issue, not anything with our actual end users of the product.

Mary Kay Ladone

Go ahead, I’d also point out that last year, if you look at the sales, Q2 to Q3, we saw a significant decline sequentially, so Q3, we really haven’t any of the comp.

Glenn Reicin - Morgan Stanley

Right.

Mary Kay Ladone

In terms of our growth.

Glenn Reicin - Morgan Stanley

Right. Okay, thank you very much.

Rob Davis

Thanks, Glenn.

Operator

Mike Weinstein of JP Morgan is on line with a question. Weinstein, please go ahead with your question.

Mike Weinstein - JP Morgan

Thank you. Good morning, everybody.

Bob Parkinson

Good morning.

Mike Weinstein - JP Morgan

Thanks. That was a good explanation in the situation and was obviously what people can ask. I would like to focus to maybe to a scene on the BioScience side. And you commented about the vaccine business in the first quarter and then here in the second quarter, and you gave your comments here to the back half of the year. I like you to give your thoughts on this business, which obviously is a high margin business with the company. And in potential is a growth driver beyond 2007. Can you think about some of your opportunities in '08-'09?

And then secondarily, if we could just focus on the market for up 180 drips and now that you have brought that manufacturing in-house, how should we think about that opportunity? My understanding is that the market is relatively sticky for existing patients. So, I assume some of that is going to be trying to increase supply availability to tracking new patients that would soon be a pretty attractive opportunity based on several numbers that your company has posted out there for that product line. So sales, would you comment on that too, and then some of the after effect?

Bob Parkinson

Sure, Michael, this is Bob, let me, maybe, you touched on a lot of things. Let me kind check it off and then Rob and Mary Kay can answer that. At the high level, we continue to be very bullish about not only the short-term but any intermediate term, but frankly the long-term prospects of the BioScience business and all components of that starting with the beginning of the earlier franchise. Secondly, the plasma proteins as a category we talked about before we certainly anticipate stable market conditions continuing. In fact we anticipate there still continue to be opportunity for pricing on plasma proteins, we see across the array of plasma proteins certainly mid, if not high, single digit growth led by the demand for IVIG.

And we are seeing wonderful contributions from what I would describe as specialty proteins. Our FEIBA been a great example -- an older product but one with additional promotional focus over the last couple of years as well as strong double digits we anticipate that will continue. And certainly a product like ARALAST is the last part of your question. It would fall under the category of a specialty protein. It was self-manufactured and has obvious implications in terms of enhancing our margin.

If we look at the longer-term potential for this product, clearly this is and I think we got into this a little bit in the March Investor Conference. This is certainly $200 million to $300 million kind of opportunity for us longer-term. We also see then the last two segments being vaccines continued increasing vitality in the vaccines business as evidenced by our strong first half we continue to be encouraged by the prospects intermediate and longer-term with not only our pandemic technology and pandemic flu vaccines but reverts back to the seasonal flu vaccine as well.

So the long-term ramifications of vaccines business I think our outlook of vaccine business is also very encouraging and then finally regenerative medicine, led by a Bio-surgery business but augmented by one of our wildcard opportunities which is our Sell Therapy program which continues to advance very nicely.

So, I covered a lot of things here, but whether it's reporting the FEIBA franchise, the immunology franchise, the array of plasma proteins, including specially proteins like FEIBA, like ARALAST in increasing strengths throughout vaccines and very exciting prospects for the future for regenerative medicine.

I think one can conclude that BioScience is a total business as one that not only has driven a lot of the turn around of Baxter over the two years, but is going to continue to drive growth in the future. So, that was a lot of stuff, but your question included a lot of stuff. Mary Kay or Rob, specific things you want to share just to augment my comment?

Rob Davis

The only thing I have to add, Bob and I think things were largely -- you guys are already aware of this. Their last opportunity is not only revenue growth opportunity that Bob mentioned, but it is also a margin expansion opportunity because once we are fully up and running in house, we will be avoiding the loyalty that we used to pay. So, in other words its, we look at it both as a margin expansion at no revenue growth as well as on top of that, the potential to really expand this business going forward. So, it really gives us benefit on both aspects.

Mike Weinstein - JP Morgan

Just two quick follow ups, and then it's up. The share repurchase commentary that, that was the higher number than you have talked about before is that accurate?

Bob Parkinson

It is, there is really, and what I wanted to make sure and I think Glen picked this up when he asked the gross and net question. But what we're really trying to what everyone knows, as we continue to see our stock price rise as we continue to see option exercises, we've actually seen a nice catch inflow higher than expected due to the different size of options. And that has afforded us the opportunity as well as just a strong cash flow operationally in the business to pick up the share repurchase at a pace that we think we can continue going forward; that's why I wanted to make sure that people understood we are above the billion dollars we had communicated going forward. That being said, we are bringing in a fair bit of cash and expect to continue to do that due to these option exercises. It's a good problem to have.

Mike Weinstein - JP Morgan

Yeah, and just to clarify on that, of that additional cash from the option exercises to repurchase rather than invest in acquisitions across the license industry just talk about that. Then I’ll drop back.

Rob Davis

As you recall at the investor conference, we laid out our capital allocation strategy that had not assumed the significant inflow of cash due to option exercises. So clearly as we make the decision to plough that back into share repurchase, we still believe we have more than enough flexibility to drive the growth and external investments and nothing has changed from that perspective and we are still generally operating consistent with that capital allocation we had laid out. So in that sense, this does not anyway change our strategic focus on trying to grow the business as well as return shareholder value through the form of the repurchase.

Mike Weinstein - JP Morgan

Great, thanks.

Operator

Larry Keusch is online with a question from Goldman Sachs. Please go ahead with your question.

Larry Keusch - Goldman Sachs.

Hi, good morning everyone.

Bob Parkinson

Good morning.

Larry Keusch - Goldman Sachs

Two questions, first for Bob. Your cash position is building here almost $2.5 billion now. Can you walk us through again just how you are thinking about uses of that in particular acquisition activity and could we see something this year and perhaps kind of target and size again.

Bob Parkinson

Well the pick up on what Rob, said in addition to our share repurchase objectives and dividend strategy. We feel we have ample cast to support business development efforts of a variety of ways, ranging from opportunities both on kinds of acquisitions to in licensing and selling. As we discussed at the March Investor Conference, we are going to remain very disciplined and how we subject prospective deals to define financial return thresholds and in addition to that, any deals that we do as we said again in March has to fit within an acceptable, what I call a strategic template that we defined for our various business development teams.

Now, having said that, I will tell you internally, momentum is building with these efforts. I am actually confident that we will begin to finalize a number of transactions of various types as we proceed through the third quarter. So we look forward, to discussing those in greater detail, when we get together for the next earnings calls. But again I want to clarify for everyone the kinds of acquisitions that we are talking about are not the big transformational things that we've discussed, but things that are complimentary to businesses that we are in today. So, you can't talk about things until they are done deals, but the quick punch line is momentum is doing. I think we are going to get various kinds of deals done in the third quarter and we look forward to discussing with you.

Rob Davis

So, with the MASS Medical, that's not a deal we had really hyped in anyway, but we see that as an important vision from bringing in good developmental talent, as well as some good technology that will work across the whole range of platforms within the medication delivery business. So that's one example of activity, and as Bob mentioned there is more to come.

Larry Keusch - Goldman Sachs.

Okay and then just two other quick ones. Second quarter, in a row, that you guys have talked about firming albumin pricing, so I am just wondering if you can give us a little flavor for what's happening in that segment. And then a clarification for, Rob, you mentioned 20% tax rate for the year, I just want to make sure that I am understanding that that is inclusive of the reported lower tax rate that you reported for the 2Q?

Bob Parkinson

Yeah. Well the albumin pricing dynamics continued to be the same they do from probably more notably in Europe where they were actually lower we would anticipate Larry, that that's going to continue. So to be specific as to how high it will go and when and so on, we won't get into that, but we don't see anything in the marketplace that would deviate from this firming trend that we continue to see. Rob you want to.

Rob Davis

Yeah. And to clarify Larry, we are saying that our full year tax rate will be approximately 20%, now that is the guidance. That includes the one time benefit that drove the rate lower in the second quarter. If you recall last quarter we signaled that we would have this favorable change in our tax grant in one of our tax favorite jurisdictions that affects us on ongoing basis, effectively lowers the rate on an ongoing basis. We had reflected that in our guidance last time. In fact we ended up getting a one time catch up benefit a little bit bigger than we expected from that, as well as I noted we had an audit settlement in another jurisdiction that I think I had even signaled in various through either calls or conferences that we know those are out there. The potential for those we just never really know the timing, because it really determined by the resolution with the foreign government. So that one time benefit is reflected, but that doesn't have any impact on the ongoing run rate of the tax rate it's really only that one change in the favorable jurisdiction to drives that rate and that we have reflected.

Larry Keusch - Goldman Sachs

Okay. Great, thanks very much.

Bob Parkinson

Thank you.

Operator

Rick Wise of Bear Sterns is online with a question. Please state your questions.

Rick Wise - Bear Sterns

Good morning everybody.

Bob Parkinson

Good morning Rick.

Rick Wise - Bear Sterns

Following up on the notion of acquisitions and the positive operating leverage that you showed us this quarter. Can you elaborate first a little more on the improved business and product mix? I mean you've talked about some things, but are there one or two drivers in your mind that played a bigger role than others.

And should we rethink with sales tracking at the upper end of the 8% if you exclude all the noise already? Should we feel like its possible that with acquisitions and everything that we might see more in the 8% to 10% gross range over the next several years?

Bob Parkinson

Okay, Rick this is Bob. In terms of the mix dynamics going on, starting at the highest level I described it as business mix. Obviously BioScience is growing at a faster pace than renal in their delivery. It has inherently higher margins and so, we continue to benefit from that as reflected in the overall corporate gross margins.

But in terms of product mix --in the interest of time I won’t go through everything -- but every one of our businesses is benefiting by focus promotionally and from a marketing point of view on higher margin products. And the discussion we had as a follow up to Mike Weinstein question on ARALAST is a great example of that, a continued conversion to recombinant.

Obviously pricing throughout BioScience, particularly in plasma proteins, is helping the margins considerably. But if you look at medication delivery and anesthesia, we talked about that being a 24% year-to-date lower versus prior year. We're projecting the same performance for the rest of the years. For the rest of the year, anesthesia has much higher margin than the rest of med delivery.

So, I will stop there, but I think there are a myriad of examples of product mix upgrade in each of our businesses that’s further augmented by the higher level issue of BioScience as a higher margin business growing at a faster rate. And those dynamics that I’ve described, we certainly foresee those continuing throughout the rest of this year ‘08 and frankly beyond.

To your second question, Rick, on organic growth rate kind of this 7% number that we threw out at the March investor conference and even in my prepared comments this morning, I further reinforce that with it being about 8% when you adjust for effects of the TT divestiture over the last four quarters. That will get off course a little bit obviously in the second half of this year because of this loss of promotion rights and benefits, which we’ve talked about. So that impacts us about a 1% in the back half of the year.

Rob Davis

Yeah, about 1% in the back half of the year, but back to your question, I mean our framework has been consistent from the start. We are looking at a 7% kind of a base case organic growth of the portfolio businesses and as we look to some of these wildcards materializing and as we look to accelerating business development, either it would be acquisitions or in-license of product and technology.

So, it’s reasonable to accept, well certainly our aspiration long-term over our five year long range plan is to exceed that 7% organic growth. Okay. I am committing to a number being more specific and so some of these wildcards do began to manifest themselves and that we do put runs on the board in terms of deals that can be in a bolt related to that base case. It would be premature probably to quantify it, but it’s clearly safe to say, our aspiration as a company is to grow our top-line at a faster rate than that 7% kind of organic base case growth that we talked about in March.

And the other thing I would add is everything that we do given our disciplined focus on achieving or exceeding financial thresholds is, I would expect that, we continue to be committed, that our margins are going to continue to be improved and bottom-line EPS will grow at a faster rate than the top-line throughout the five year financial plan.

Rick Wise - Bear Sterns

Thanks and two last questions. One: anything you talked about cards, anything we should ask you about, an update on any of the wildcard projects? And last, I feel like somebody has to ask about the COLLEAGUE in a little more detail. Happily, you caught the issues early, happily it seems limited, but how did it happen at a time you seem to be executing so well?

How can you reassure patients, customers, and the FDA that this isn’t going to keep happening, and just maybe on a personal level, Bob, do you think it hurts your franchise longer term, that this keeps recurring. Thank you.

Bob Parkinson

Yeah. Let me start with the COLLEAGUE and then work back to the status of the wildcards. So those are two very different kinds of questions, but the COLLEAGUE thing, given the announcement last night, it's kind of a proverbial elephant in the room. So I am actually glad you asked it. The obvious question is how did something like this happen?

I think it's probably fair to say that given the unique nature of this thing, it's not something that one would typically pick up during conventional or traditional kinds of validation efforts. This was really an extreme real world operating scenario that, in certain conditions the users, specifically a critical care nurse, one who is extremely familiar and in fact very adept with how she or he programs the device could actually program a series of commands at a very rapid rate, whereby the capacity, I don’t want to get too technical, but whereby the capacity of the buffer becomes overloaded and that was really the phenomenon. So the question is we should have had this and we didn't. I think it was a real world situation that was extremely difficult to simulate, but the reality is we should have got it, we didn't, it's that simple.

So the question is how do we learn from that, how do we get better going forward? I mentioned in my comments we have a fix. The issue isn't the fix. The issue now is in testing the fix and subsequently validating the fix, understanding by implementing the simple "fix," are their unintended consequences or ripple effect someplace else in the system? And we don't think that's the case, but given our experience through out this COLLEAGUE situation and then clearly more recently with this, you can only characterize it as a disappointment even though we did catch it early. Nonetheless, it's a significant disappointment. We can't afford to screw up again. And I don't think we will. But we learned from the experience and we go forward and we try to get better.

The second part of your question on COLLEAGUE relative to long-term ramifications, look if we move ahead and complete the remediation consistent with the time table that we spelled out. If we can work through the consent decree to get our certification from PAREXEL, get the agency back here in the third quarter for fuller obligations for the terms of the consent decree and be in a position hopefully by year end if not before to re-commercialize COLLEAGUE.

I am confident we will manage through all this. But having said that, we are not oblivious to the fact that patience on behalf of our hospital customers does have its limits. This situation does not help. I would not say assuming we can execute moving ahead in accordance with how I believe we can, that it will fundamentally hurt the franchise, but we can't afford any more mistakes and that's as direct as I can be on the COLLEAGUE situation.

Your first question is a very different question, which is kind of the update on wildcards. There is nothing new to report other than I would say we haven’t had any milestone disappointments on any of those programs. We will be more forthcoming on aspects of our flu program both the pandemic and the seasonal flu vaccine program in the coming quarter and certainly in the next half. There are a lot of things going on there, they are very positive. So, I am actually increasingly positive about the prospects of our flu wildcard.

The all time IVIG wildcard, nothing new to report. I think you all know that Phase II clinical is being conducted by Cornell Medical Center will be concluded sometime in the third quarter. We'll see what outcome there is, but there is no news on that front.

The whole cell therapy program, actually I am having a two hour project update tomorrow with the team, but I have already gathered time to clip notes versions, things continue to progress very well there ranging from enrollment of patients in the Phase II clinical to all other aspects of that program. So, we continue to be very bullish about that.

Halozyme, we commented on that in the prepared comments. We're actively engaged in an array of clinicals. They continue to be very excited about that technology. Anyway, I will stop there, so this isn't a detailed R&D review. But no disappointments of the wildcards and I would think on a number of them, if not most of them, perhaps even more encouraging position today, then when we discus them in March.

Rick Wise - Bear Sterns

Thanks so much, Bob.

Bob Parkinson

Okay.

Operator: Ben Andrew of William Blair is on the line with a question. Please go ahead with your question.

Ben Andrew - William Blair

Hi good morning. Just wanted to ask about plasma collection. I saw some data recently that U.S. plasma collections are up about 20% year-to-date, so about 12.5 million liters, which is where they peaked back in '03. Do you feel like the pace of plasma collection growth is picking up speed? And what do you really project for '07 and '08 in terms of industry overall collections?

Rob Davis

Ben, this is Rob. Yes, I think you have seen collection pace increase across the industry. Obviously this is in large part driven by the fact that demand continues to be very strong and frankly above expectations. So we do not believe in any way that collections are outpacing demand. As we’ve said many times, there is as much of a risk of under collecting in the strong demand market as there is in over collecting. So in that sense, we are kind of, frankly, encouraged by the collections, because that means the industry is keeping pace.

As you look forward, with that being said, I don’t believe, and this is our internal view, that we are going to continue to see the kind of growth that we’ve seen this year. Going forward, we’ve signaled on several different occasions long term, that we look at the plasma market to be growing at around 10% total and that is about 6% volume. So you can back into what that has to be from a collections perspective. So, while we are benefited from this, we feel good about it this year. It doesn’t change our long term aspects of this or our long-term outlook at this time.

Ben Andrew - William Blair

Okay, and then on the manufacturing side. How are things going with the new plasma facility? Are the yield improvements there, that you expected, coming along? And when do you think you’ll shut down the older facility in Glendale.

Rob Davis

Yes, if things continue to come along well, we have approval in that facility for our alkaloid versions of IVIG and albumin and we are starting to ramp up production. As you recall we’ve signaled, given the fact that we shut out that facility globally, we are still in the midst of working through registrations outside the United States. And as a result of that really don’t expect to be fully up and running in that facility until probably early 2009.

We will expect to get liquid IVIG approved here sometime in 2008. But so, by the time we get that approved, then do the same international registration process, as well as bringing out the production of lyophilized products, as we get that registration and still have a couple of year process to get this fully up and running. Nothing however tells us that we are either behind our timelines or have run into any issues.

Ben Andrew - William Blair

Okay. Thank you.

Operator

Glenn Novarro of Banc of America is on the line with a question. Please state your question.

Glenn Novarro - Banc of America

Thanks. I have two questions. One, on the BioScience, sales were up 20, FX contribute 5 points. Can you break out what overall price contributed to the BioScience growth in the quarter and then maybe comment about how sustainable that price and benefit will be on 2008. That’s question one.

And then just a follow up question on the COLLEAGUE. I am imagining, if the consent decree does drag on for a few more months or a quarter longer than we think, one risk would be potential pump contracts coming up that maybe impacted. I am not aware of any pump contracts coming up, but can you just clarify that for me? Thanks.

Bob Parkinson

Yeah Glenn. This is Bob. Let me comment on the COLLEAGUE thing, then I will have Mary Kay or Rob, maybe respond on your price question on BioScience. As I think, typically our pumps are contracted as part of a broader IV solutions, IV set bundle kind of a contract. And actually, virtually all of those contracts with the major groups are extended out in the future, and in most cases fairly significant term. Okay, so given that there aren’t any significant overall contracts or certainly pump segment contracts that are coming up for renewal in the near future, so there just aren't.

Glenn Novarro - Banc of America

Okay. Good that’s very helpful.

Bob Parkinson

There may be, there are a few isolated single accounts here, Glenn, but no there are no biggies.

Glenn Novarro - Banc of America

Okay, good.

Bob Parkinson

Okay. Mary Kay, why don’t you comment on the price one?

Mary Kay Ladone

Glenn, in terms of price in most of our products we have very strong volume growth this quarter. I'd say volume growth probably averaged in the high single digits across Bioscience. We have some products where volume growth was significantly higher than that. And in some cases I'd say even at the low end. Some products grew from a volume perspective in the mid-single digits.

Obviously pricing within the plasma proteins area continues to improve. Sequentially though pricing was maybe up across the board a couple of percent, year-over-year the gains are a little bit larger. Overall if you look at margin gross profit, dollars within BioScience, still the primary driver is the mixed shift to some of the higher margin products, Liquid IGIV, ADVATE, FLEXBUMIN for instance. So about 70% of our margin improvement in BioScience continues to be volume, mix shift and cost reductions actually, and about 30% is price.

Glenn Novarro - Banc of America

Okay. Thanks Mary Kay.

Mary Kay Ladone.

Do we have time for one more question, John?

Operator

Thank you. Our final question is from Dhulsini de Zoysa from Cowen. Please go ahead with your question.

Dhulsini de Zoysa - Cowen

Great thanks. Bob that was a very good explanation of the COLLEAGUE in our industry in recent times, but I was wondering if you could just help us understand the tie up with Lucent. How this didn’t bubble up from overseas, maybe put in context, what the triple channel pump represents as a percentage of overall COLLEAGUE pumps overseas. So, we can understand, and how the past year that you've been re-mediating, this didn’t arise there. And then if I missed it, I am sorry, but did you give any ADVATE number for the quarter.

Bob Parkinson

Yeah. Dhulsini, that’s a great question on COLLEAGUE, I will answer that. And just to clear the ADVATE Dhulsini, Mary…

Mary Kay Ladone

ADVATE, Dhulsini was almost $300 million in the quarter.

Dhulsini de Zoysa - Cowen

Okay, thank you.

Bob Parkinson

Okay, back to your question on COLLEAGUE, which is actually a very practical question? The reality is the upgraded triple channels being re-mediated in the U.S., are a different software version than what we had moved ahead with in the remediation outside the U.S. Okay. It incorporated some additional functionality and features which again, I am not going to get into too much detail or too technical. We’re contributing factors to this buffer issue that I described.

But simply stated that’s why the issue that manifested itself in the U.S. had not previously manifested itself outside the U.S., where the pumps, both the single and the triple, actually are working very well. Our plan, I will tell you however, was to take the new software version with the additional functionality in the U.S. and overtime changes through our COLLEAGUE installed base and markets throughout the world. In fact, when we recalled the 4500 COLLEAGUEs, there were a handful of those that were out in two or three international market.

And the reason for that is, we had gone over into a new production in Singapore with the new software version that described for the upgraded channel, triple channels in the U.S. and because we're at the early stages, a few of those devices had gone out to international markets. Fortunately we are able to catch that. You see, I think only not more than 20 devices actually had, 30 devices or something like that, a very low number had actually made it to hospitals. And so, that simply stated, the reason for the issue in the U.S. versus what’s continue to be very reliable performance outside the U.S.

Dhulsini de Zoysa - Cowen

And then we don’t need to worry a bit, this might actually…

Bob Parkinson

No.

Dhulsini de Zoysa - Cowen

Okay, great. Terrific, thank you.

Bob Parkinson

Well. Thanks Dhulsini.

Operator

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

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Source: Baxter International Q2 2007 Earnings Call Transcript
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