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Hospira (NYSE:HSP)

Q2 2012 Earnings Call

August 01, 2012 9:00 am ET

Executives

Karen King

F. Michael Ball - Chief Executive Officer, Director and Member of Science, Technology & Quality Committee

Thomas E. Werner - Chief Financial Officer and Senior Vice President of Finance

Sumant Ramachandra - Chief Scientific Officer and Senior Vice President of R&D, Medical & Regulatory

Analysts

David H. Roman - Goldman Sachs Group Inc., Research Division

Aaron Gal - Sanford C. Bernstein & Co., LLC., Research Division

John M. Putnam - Capstone Investments, Research Division

Ami Fadia - UBS Investment Bank, Research Division

Matthew Taylor - Barclays Capital, Research Division

Marshall Urist - Morgan Stanley, Research Division

Gregory B. Gilbert - BofA Merrill Lynch, Research Division

Shibani Malhotra - RBC Capital Markets, LLC, Research Division

Operator

Welcome to Hospira's Second Quarter 2012 Conference Call. [Operator Instructions] I will now turn the call over to Karen King, Vice President of Investor Relations. Karen, you may now begin your conference.

Karen King

Thank you. Good morning, everyone, and welcome to our second quarter 2012 conference call and webcast. Participating in today's call are Mike Ball, Chief Executive Officer, Hospira; Tom Werner, Senior Vice President, Finance and Chief Financial Officer; and Sumant Ramachandra, Senior Vice President and Chief Scientific Officer.

We will be making some forward-looking statements today, which are subject to risks, uncertainties and other factors that may cause actual results to differ materially from those indicated. A discussion of these factors is included in the Risk Factors and MD&A sections in Hospira's latest annual report on Form 10-K and subsequent Form 10-Qs on file with the SEC. We undertake no obligation to release publicly any revisions to forward-looking statements as a result of subsequent events or developments.

On today's conference call, non-GAAP financial measures will be used to help investors understand Hospira's base business performance. These non-GAAP financial measures are reconciled to the comparable GAAP financial measures in the press release and Form 8-K issued this morning and are also available on the Presentations page in the Investor Relations section of our website. Also posted on our website is a presentation of complementary materials that summarizes the points of today's call. We do not speak directly to the materials. It is for your reference to use as an enhanced communication tool. You will find the presentation on our website at www.hospirainvestor.com.

Finally, we will be ending the call at the top of the hour this morning. [Operator Instructions] With that, I'll now turn the call over to Mike.

F. Michael Ball

Thanks, Karen. Good morning, everyone. Welcome to our second quarter 2012 conference call. I will begin today's call by providing an update on our quality remediation efforts and growth initiatives, followed by a discussion of our second quarter sales results, which, like our adjusted EPS, were in line with our expectations and those of the Street. Tom will then provide a deeper dive into the financials and wrap up with a discussion on guidance.

In line with the approach we have adopted since the acceleration of our remediation activities last year, we're providing as much disclosure as we can under the circumstances, including a list of FDA inspections since our last quarter call. We continue to progress with our remediation and move towards recovery, making for a very busy quarter. We continue to engage in constructive dialogue with the FDA, meeting with them on several occasions both at the agency's headquarters and the district offices. We had several FDA inspections both at our plants and at our corporate headquarters. Third, we continue to progress with our remediation efforts at Rocky Mount. Our annual preventive maintenance shutdown went as planned, and we are bringing the lines back into production. Fourth, we are sharing our learnings at Rocky and other facilities across the organization to ensure implementation of best practices and to holistically put in place modern and robust quality processes and systems.

As our remediation program progresses across our plants, we have uprooted additional issues, some of which have unfortunately resulted in product recalls, inventory loss and production disruptions. We are driving to root cause and implementing corrective actions. As we have said in the past, we believe identifying and resolving these issues signify that we are moving in the right direction on our journey to achieving sustainable compliance.

Let me provide additional details on some of these activities, starting with Rocky Mount. First of all, as I mentioned, we've made significant progress with our remediation efforts at the plant. We went into our midyear scheduled maintenance shutdown in early July. 10 days later, we started the plant back up in a phased approach and are returning to the 60% to 70% production and release levels. We expect to remain at this level during the third quarter and then modestly increase through the end of the year. During the maintenance shutdown, we took advantage of the downtime to advance our modernization at the plant, including completing various facility upgrades and commencing activity to fully automate our visual inspection process. Over time, these efforts will lead to greater efficiency at Rocky and ultimately faster release rates and improved supply levels.

Second, our intent is to begin ramping down the level of consultants at Rocky. We are building up a robust number of trained internal employees to do the work on the plant floor, and by year end, we expect the number of consultants to gradually decline as their role becomes limited to overseeing remediation activities. We are pleased by the progress at the facility, and I want to thank all of those at Rocky Mount for their tremendous work and effort.

And third, and I know many of you are looking forward to an update on our interactions with the FDA, we have continued to have constructive and productive dialogue with the agency, including 2 meetings on Rocky Mount, during which we discussed our comprehensive action plan and our progress to date. One of the meetings was at the FDA's headquarters, or the Center, and included representatives from districts, as well as the Office of Compliance and the Office of Drug Shortage. While final minutes of the meeting are circulating at the agency for comments, we believe the FDA has accepted the work plan that we previously submitted. The agency acknowledged that we were moving in the right direction with the right level of commitment, but indicated they needed to see continued progress. We realized that much work remains to be done but left the meeting encouraged.

As part of our continuing global quality efforts, we are reviewing our quality systems across all of our plants. Where there are gaps, we are bringing in third-party support on an interim basis as we improve the system. We've already started implementing this at Austin and Boulder, and we'll be looking at the other plants as we proceed through our assessments. The oversight is on a much smaller scale than what we have at Rocky Mount and commensurate with the assessment outcome and required activities. For example, at Austin, we brought in a handful of consultants to assist in our quality improvement efforts.

As far as recent inspections, at our Clayton plant, which was originally cited under the 2010 warning letter along with Rocky Mount, the FDA conducted a full cGMP inspection, which resulted in 6 noncritical observations regarding stability studies, sampling documentation and methodology and equipment validations. It is important to note that investigators did not cite any of the observations as repeat observations, and in fact, each of the 3 investigators made positive comments regarding the progress we have made at Clayton as part of our quality journey. In addition, as discussed during our first quarter earnings call in May, we previously experienced some manufacturing issues at the plant related to the water for injection system and the observance of particulate in final product in test batches. As a result, we did not release any significant amount of product during the quarter at Clayton. This has resulted in a shortage situation with propofol, as well as impacting supply to certain contract manufacturing customers. We believe we have addressed the root cause of the issues and have taken appropriate steps to correct these issues, but need to demonstrate the effectiveness of our corrective actions. If all goes according to plan, we should be back up and manufacturing sometime in the third quarter and releasing product in the fourth quarter.

At our Boulder plant, the FDA performed an inspection at the facility and issued 7 observations. Boulder is a small oncolytic API plant, and the observation centered around cleaning validation, process validation and laboratory investigations. We have responded the FDA with our plan to address the observations, and in a subsequent meeting, the agency did not object to the scope of our planned corrections.

At McPherson, the FDA came back to the plant for a focused inspection on the issue related to overfilled Carpuject vials we experienced earlier this quarter, and no observations were issued.

At ZHOPL, which is our joint-venture facility in India, the site had its first full cGMP inspection since its initial inspection, and no observations were issued.

At Austin, just this Monday, the FDA began both a follow-up inspection and a general cGMP inspection of this site.

We recognize that we are receiving heightened scrutiny from the FDA as the agency is interested in monitoring our progress and ensuring compliance across our manufacturing facilities. We support this ongoing interaction with the agency as we believe it will not only help ensure that our remediation efforts meet their expectations, but it also supports the holistic improvement initiatives we're committed to making across our manufacturing footprint.

Finally, on the device side of the house. We continue to make progress on our comprehensive device review and are advancing our efforts in this regard. Although most of the investigations are targeted to be completed towards the end of the year and end of 2013, a few corrective actions, including field recalls, have already been initiated. Also, the FDA recently inspected the device design controls and complaint system at our Lake Forest facility and issued a 483 with 10 observations. The observations principally related to complaint handling and documentation, supplier quality and regulatory labeling. We are working on a response to the agency, which is due in early August.

So as you can see, we had a very busy quarter and continue to move forward with both our pharma and device remediation efforts. I realize that some of you are concerned about the length of time this is taking and that additional issues keep bubbling up. However, from my perspective, we are making progress, and we are seeing encouraging signs of improvement. At Rocky Mount, many of our metrics are now moving in the right direction, such as first pass quality and production schedule adherence, which are leading indicators of the health of our plant. Across our facilities, with the vigilance of our strong new operations and quality leadership, we are closing out investigations faster, using a more effective and vigorous process to drive to resolution. Using the swamp analogy I've referenced over the past several quarters, we are draining the swamp and dealing with the gators we have uncovered. As I've reiterated numerous times, I am committed to resolving our quality issue and getting as much done in 2012 as possible. I believe the FDA understands, and I know that our employees do as well, my commitment in this respect. But it is not a quick fix. It's complex. It takes time and money, and there may be additional gators yet to be uncovered along the way. That said, I know we'll get through this. It's a matter of when, not if. And when we do, we'll be in a much stronger competitive position.

We also remain focused on our growth initiatives, and we are moving forward with our growth expansion plans and the related regulatory filings. During the second half of the year, we expect to make significant progress with the goal of filing approximately 50 new-to-country submissions by the end of the year. This is in line with our original timeline, and we expect to start seeing commercial gains in the 2014, 2015 time frame.

In addition, we were pleased to have recently transitioned China from a third-party distribution model to a direct commercial presence. We currently have a staff of approximately 60 employees there, who celebrated the first sales to hospitals under our new direct model in China.

Our overarching goal is to grow profitably, which, admittedly, is challenging during the remediation process. However, we believe that as we reduce complexity at our plants as part of the remediation process, we will realize additional optimization as a natural outcome of the process. We're also continuing to drive product rationalization, and towards this objective, we initiated plans in June to exit a niche solutions product line over the course of the next 6 months. Furthermore, we continue to aggressively pursue price increases for products across our regions.

On the growth side, our relationship with Celltrion is starting to bear fruit. During the quarter, we filed our biosimilar dossier with the European health authority for infliximab, a biologic that treats rheumatoid arthritis and other indications, which we will market under the brand name INFLECTRA. The dossier is currently under review, and we have been in active communication with the health authority. We plan to apply the experience we gained with our current 2 biosimilars to commercializing INFLECTRA at market formation.

In addition, this month, we will be relaunching oxaliplatin, an oncology drug. You may recall we were the first to launch oxaliplatin in 2009 after successfully challenging the originator's patent.

Finally, before moving to the sales discussion, I'd like to highlight 2 recent additions to Hospira. We were very pleased to announce yesterday that Dennis Fenton joined our Board of Directors. Dennis' unparalleled experience with biologics manufacturing and operations quality make him an excellent fit for the board, and we look forward to working with him, enjoying the benefits of his contributions. We also welcomed Neil Ryding during the quarter to the newly established role of Senior Vice President, Devices. Neil, with his extensive device background, will bring significant focus and experience to this billion-dollar business.

Turning now to our sales results for the quarter. As a reminder, all references to net sales results are on a constant-currency basis, which excludes the impact of foreign currency fluctuations. Our press release provides full details on the impact of foreign currency on net sales by segment and product line. Net sales were relatively flat compared to the second quarter of 2011. Strong volumes in certain specialty injectable products outside the U.S. and higher device sales were offset by a difficult comparison to second quarter 2011 performance, which saw strong U.S. sales from the launch of docetaxel, as well as a positive contribution from several other launched compounds.

By product line, global specialty injectable net sales decreased 2% for the quarter. Very strong SIP performance in EMEA and APAC were not enough to offset soft results in the Americas.

Let me now discuss performance by region. In the Americas, specialty injectable sales were down 6% for the second quarter. The decline related to several factors. First, docetaxel. Docetaxel continued to perform well in the quarter. Market share remains at almost 50%, with pricing still at approximately 60% off the branded product pricing, higher than expected levels. However, the second quarter of 2011 was the first full quarter post-launch for docetaxel, which creates the difficult year-over-year comparison. Second, propofol. As I mentioned earlier, due to manufacturing issues at Clayton, we released very little propofol. What we did release was from inventory manufactured in 2011. Third, we saw year-over-year price declines on some of the products we launched in the U.S. in 2010 and 2011, such as gemcitabine, due to competitive market conditions. And fourth was the impact of supply issues primarily driven by remediation activities, which affected several of our products, including anti-infective and anesthetic drugs. Partially offsetting decline in SIP in the Americas was continued strength in Precedex during the quarter.

Turning now to the EMEA segment. Net sales of specialty injectables were up 20% compared with the second quarter of 2011. Highlights during the quarter were meropenem, which continued to perform exceptionally well, and Nivestim, our biosimilar filgrastim product. The additional sales staff we added has been beneficial in increasing adoption of filgrastim across Europe.

In APAC, net sales of specialty injectables increased 5% in the quarter, primarily driven by initial stocking from our entry into China and continued positive performance of Precedex in both Japan and Korea.

Turning now to Medication Management, global net sales increased 6% during the second quarter. We have seen increased momentum in customer demand for our smart infusion pumps and IV clinical integration systems. Sales in our Other Pharma product line were down 4% in the second quarter compared to the prior year quarter primarily due to softness in solutions as a result of supply constraints.

With that, I'll now turn the call over to Tom for an overview of our financial results. Tom?

Thomas E. Werner

Thanks, Mike. Good morning, everyone. Mike has taken you through the sales, and I'll run you through the rest of the income statement, cash flow and then talk a little bit about guidance. First, adjusted gross margin as a percent of sales in the quarter was 36%, which was down from the 41% in the second quarter of 2011. This is due primarily to costs associated with strengthening our quality systems, lower manufacturing volumes, inventory losses, particularly in Clayton, as well as price declines on some of our 2010 and 2011 product launches that Mike mentioned before.

Moving to R&D expense, it was up 27% in the second quarter to $84 million. This primarily is a result of higher biosimilar clinical trial spending, as well as the continuation of our global expansion program. R&D as a percentage of net sales was 8% compared to 6% in the second quarter of last year. SG&A expense for the second quarter was $170 million, up 9% from $156 million from the same period last year. The increase is primarily associated with increased selling and promotional expenses, as well as slightly higher corporate expenses.

Adjusted operating income was $117 million compared to $212 million in the second quarter last year. Adjusted operating margin was 11% compared to 20% in last year's second quarter. Our tax rate in the quarter was 19% versus 23% on an adjusted basis in the second quarter of last year. Reduced rate results from increased expenses in higher-tax rate jurisdictions, as well as a greater mix of operating income in lower-tax or tax-free jurisdictions. And finally, adjusted diluted EPS for the second quarter was $0.51 compared to $0.94 for the same period last year.

Turning next to cash flow. Cash flow from operations for the 6 months ended June 30 was $216 million compared to $253 million for the same period last year. The decrease primarily reflects lower income from operations in 2012, which was partially offset by working capital improvements, driven by lower inventory levels as we continue to work down our inventories. Capital spending for the first 6 months of this year was $137 million, relatively flat with last year. The largest portion of the capital spend this year reflects investments we're making relative to our capacity expansion efforts, primarily at our greenfield pharma plant we're building in Vizag, India. Our cash balance at June 30 was $720 million, up from $598 million at the end of last year.

Moving next to guidance for the full year. We're maintaining our net sales guidance of down 1% to up 2% on a constant-currency basis. However, the impact of foreign exchange is becoming more of a headwind and is now expected to contribute between negative 1% to negative 2% of decrease in sales. We're maintaining our gross margin range of 35% to 37%, but we do anticipate we'll be at the low end of that range primarily as a result of a couple of items: first, greater-than-anticipated freight and distribution as we work diligently to deliver available product supply to our customers in a timely manner; and second, potential inventory losses and personnel expenses as we review our quality systems across all of our plants and assess outcome and required activities. For R&D, we're maintaining guidance in the 7% to 7.5% of sales range, but we anticipate that with the spending so far to date, we'll end up more towards the upper end of that range. We do expect SG&A to come down sequentially from the second quarter into the third quarter. As a result of all those items, we expect adjusted operating margins to be in the range of 10% to 11%. For adjusted EPS, we believe we'll be at the low end of our original guidance range at approximately $2 per share.

Regarding our previous remediation cost range of $300 million to $375 million, which includes remediation activities for both pharma and devices, while we've spent $235 million to date, our current estimates indicate we'll come in toward the upper end of the range, and we'll continue to carefully monitor these expenditures. We're decreasing our cash flow from operations guidance to a range of $475 million to $525 million primarily as a result of lower operating income both on a GAAP and on adjusted basis. In terms of calendarization, we expect to be down on both a sales and earnings per share basis sequentially from the second to third quarter, and then up again from the third to the fourth quarter, which has historically been our strongest sales quarter of the year.

With that, I'll turn the call back to Mike for some final comments.

F. Michael Ball

Thanks, Tom. The second quarter was a busy one for us, with results in line with our expectations. We made good progress at Rocky Mount with our remediation activities. We continued our constructive dialogue with the FDA, and I was pleased with the outcome of our meetings with the agency. I believe they understand that we are committed to resolving the issues under the warning letter, and I believe, too, that they understand that we are committed to applying what we've learned at Rocky on a holistic basis to reinforce our entire foundation. And toward that end, we've undertaken activities at several of our other facilities, which have surfaced some additional issues, a few more gators in the swamp, so to speak, that we are addressing. This has unfortunately created some product shortage situation and required additional effort, cost and time on our part. But while our overall quality initiatives are proving more extensive than we originally thought and may take more time to complete, it's the right thing to do for Hospira and for our customers and the patients they serve. We remain committed to driving as much improvement as possible this year while, at the same time, prioritize the needs of our customers to the best of our ability given the challenges with which we are dealing. We look forward to reaching the other side of our quality remediation, so we can resume the steady supply of products our customers and patients rely on and ultimately enjoy the benefits from our global expansion program and our investment in biosimilars. We are absolutely confident that once we get through this, we'll be even stronger than before.

And with that, operator, we are ready for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of David Roman with Goldman Sachs.

David H. Roman - Goldman Sachs Group Inc., Research Division

Mike, I really appreciate all the detail on the FDA, and the update is extremely helpful. I was hoping you could address one question, and then I have a follow-up for Tom. In terms of the progress that you're making on some of the outstanding warning letters, can you maybe just help square that up for us in confidence in the progress you're making versus the new issues that you're unearthing and how we kind of think about the trajectory here? Is this the type of situation where as you resolve one issue, another issue comes up, so the totality of the time toward complete resolution is still very hard to predict and potentially a little bit longer than you had initially contemplated? Maybe help us square those 2 things together.

F. Michael Ball

Okay, David. So let's just talk about, first of all, the progress we're making in terms of the plants under the warning letter, and the 2 plants under the warning letter are Rocky Mount and Clayton. So we had, as I said, an inspection at Clayton this quarter. We got a 483 with 6 noncritical observations, and the gestalt at the end of the session with the investigators, as I mentioned previously, was we had made good progress. We seemed we're living up to our commitments, but there's additional work to do. And so with respect to our plants, I would say that, that's where I see them right now, good progress being made. We're living up to our commitments, but there's still a lot of work to be done. With respect to the issues surfacing, you're correct in terms of there are more issues than we had previously thought, so as we are knocking out issues, more issues keep surfacing. But remember, this is deliberate. We are trying to drive to the surface all the issues we can in 2012 and take care of them, so the additional issues that you see surfacing, which often you see in terms of recalls, is really a sign of progress. It's not a sign of deterioration or going backwards. So with our new team onboard, what I've asked them to do is just drive into the issues, find them, uproot them, drive to root cause and get them solved. And so I think in that way, I feel very good about the progress. So far from being discouraged about the issues that are surfacing, I'm encouraged that we're getting them out in the open and we're able to deal with them. And that is a very important thing because the big concern before might have been that these issues were not manageable. All the issues that we've seen surface have been manageable, so again, manageable issues.

David H. Roman - Goldman Sachs Group Inc., Research Division

And then for Tom, in Mike's prepared remarks, he talked a little bit about starting to ramp up production in the fourth quarter on Rocky Mount, I think, toward that 60% to 70% level. How should we think about the impact of production levels on your margin profile? And then once you do start to ramp up, how long does it take to start to see a positive inflection point on the gross profit line?

Thomas E. Werner

The production in Rocky, we think, will run at 60% to 70% through the third quarter and then gradually start to take it up into the fourth quarter. I'd say improving the output just by itself is probably going to be a little bit more evident on the sales line than it would be on the margin line. There'll be some minor impact, but the way the overhead structure's put together in Rocky Mount moving from, say, 65% up to 75%, up to 85%, there is some leverage we get on the overhead, but it's not a great deal. So I think over the longer term, if we can get the production up, keep the lab in sync with the quality coming off the line, we should have some opportunity to begin to take some of the people out of the operation. But in the near term, I wouldn't expect a lot of leverage from that. It's maybe more of a sales opportunity as we work backorders down and get back into a better supply position.

Operator

Your next question comes from the line of Ronny Gal with Bernstein.

Aaron Gal - Sanford C. Bernstein & Co., LLC., Research Division

Also kind of a question and a follow-up. The first one is given the problems in Clayton, I was a little bit surprised by the strength of the U.S. sales. Can you help us understand, were you able to take price increase? I think you alluded that. Where were they, and should we continue to expect them? And secondly, as I think about your quality progression, propofol will not be sold in the third quarter or just begin to sell in the third quarter and significantly more in the fourth. Should we see a large increase in sales just from that and oxali as we approach the year end?

Thomas E. Werner

I'll take the second part of that, Ronny. In terms of the sales progression, as we move from the second to the third quarter, as we indicated in the prepared comments, we'll see a decline in sales, really, relative to several items. First, as we've gotten back into full supply on vancomycin, there was some stocking on that that took place in the second quarter. We don't see that continuing into the third quarter. Second, in contract manufacturing, we've just had some timing of orders that moved into the second quarter or to the fourth quarter which came out of the third quarter. And then we expect to see continued declines on docetaxel and gemcitabine. As you move into the fourth quarter, propofol will be coming back. Oxaliplatin, given the competitive landscape, it's not enough sales, at least the way we forecasted it, to really move the needle. The other thing that will help us in the fourth quarter is continued growth in Precedex both in the U.S. and outside the U.S., as well as continued strength in MMS both in the U.S. and Canada.

F. Michael Ball

And from a pricing standpoint, Ronny, in the second quarter, no, we did not have price increases in the second quarter. What we are looking at doing as we move forward is looking aggressively at price increases in different areas such as large volume solutions, where, I believe, the value of the product is not being reflected in the price of the product in the market.

Thomas E. Werner

I'll add one other thing to Mike's comment on the sales just relative to the strength. We did have price declines on some of last year's launches and prior years, but Precedex continues to grow quite well. We're back in the market full swing on pumps. Europe got a really outstanding quarter, probably the best quarter in SIP that I can remember. So we've been able to sort of maintain share relatively in the U.S even amidst the supply issues, and we've got other parts of the business that are growing for us.

Operator

Your next question comes from the line of John Putnam with Capstone Investments.

John M. Putnam - Capstone Investments, Research Division

Mike, I was wondering if you might talk about drug shortages, how many you have right now or that you're in and what that might have compared to in the first quarter.

F. Michael Ball

So with respect to the drug shortage situation, so we are still in the midst in this country, of course, in a drug shortage crisis. Probably, something like 100 products are still in drug shortage. If you look at all the companies and kind of our share of those drug shortage products, it's still approximately 1/3, which isn't that surprising because that's basically what our unit share is of the U.S. SIP market. So we and virtually all other manufacturers are having issues either under a warning letter or some other issue reflected in drug shortage. So that continues to be a problem.

Operator

Your next question comes from the line of Ami Fadia with UBS.

Ami Fadia - UBS Investment Bank, Research Division

Mike, if you could give us a sense of what are the things need to happen for the operating margin of the company to go back up to about the 20% range? And if you could sort of give us a sense of what will it take for the gross margin to come back up closer to 40% and how your investment in R&D in Europe can impact margin and when should we see that turn?

Thomas E. Werner

I'll take the question. In terms of operating margin to 20% and the gross margin to 40%, what we've been saying over the past several quarters is that while we've added quite a bit of cost here to address the quality issues, we do expect that with better first pass quality and better yields off of our lines, we'll see the ability to take some of these resources out of the picture. You add to that a focus on product line rationalization, as Mike mentioned, reducing complexity in the plants, hoping to strive for longer runs, fewer changeovers, product that we can run higher volumes on. And I think thirdly, we really believe that the value for these products right now is not really being recognized in the marketplace. And as we mentioned in the prepared comments, we're aggressively going after price increases in various of our product lines. So how soon that happens, how quickly, that remains to be seen. We're really not in a position to talk about 2013 and beyond, but those are some of the drivers that we see would head us in that direction.

F. Michael Ball

And just to build on that, Tom, over the longer term, we're looking, of course, to getting Vizag up and running in the 2014 time frame. At the same time, you mentioned Europe. We will be getting not only the global expansion molecules in there but also more biosimilars, so that will give us some opportunities for margin expansion. So as you kind of look at things as a continuum, you can see some drivers in the midterm that can give us, in addition to what Tom said, some additional lift.

Operator

Your next question comes from the line of Matthew Taylor with Barclays.

Matthew Taylor - Barclays Capital, Research Division

I just wanted to understand a little bit better what you're telling us about the different plants through the balance of the year and looking into next year. So it sounds like you have some confidence now that you're going to be able to ramp up Rocky volumes in the fourth quarter. Could you just tell us a little bit more about what gives you the confidence and why is it happening in that time frame, which is maybe a quarter beyond what you initially expected at the upper end of your range? And then in terms of the other plants, with Clayton, specifically, and some of the other observations, you said they weren't -- they were very manageable observations, but can you help us with some color in terms of what gives you the confidence there to be able to get propofol back up in the fourth quarter?

F. Michael Ball

Okay, so let's just work through this then. So in terms of Rocky Mount, as we look at it, what we said at the start of the year was we had a wide range from $2 to $2.30 as EPS number depending on which scenario held true. Scenario one, as you recall, was essentially that Rocky continued at that 60% to 70% rate through the year, and then that directed us to the lower end of the range. The other scenario had us having an inflection point midway through the year, and this would then take us towards the midpoint of the guidance. So what we've seen with Rocky then is a lot of issues, manageable issues, but it is taking time to get through them. And remediation does affect supply. So as we've got resources on remediation, it does not allow us to fully get supply out. What we're anticipating is we keep going at that rate in the third quarter, and then what we said very deliberately in the script is a gradual increase in the fourth quarter. So what I'm expecting right now then as we get through the third quarter is that we will be managing the supply up as remediation goes. Now we have a couple of other things that we did not envision when we put out our original guidance, and you referred to one of them, which was Clayton. So as I look at Clayton then, we have been through this with a fine-tooth comb in terms of what the root cause is of this particulate matter and our water for injection issues. We believe we have identified root cause, but right now, in the full transparency, we are working through to make sure that the fix we have against that root cause is working. The expectations from experts both inside the company and outside the company are that these fixes will work, and that's what gives us some comfort to say we should begin manufacturing some time late into the third quarter, but propofol release will not be until the fourth quarter. Of course, on the next quarter call, we'll be able to tell you whether or not that was successful, but at this point, we think there's a better chance than not that this plant gets back up and running again. With respect to our other plants, so as you look at McPherson then, recall that we had a full cGMP there at the end of last year. We got 6 noncritical observations. The agency then came back in, as I referred to, did a for-cause inspection on our overfills and issued no observations. So what that told us is that we have very manageable situation within the McPherson plant. As it pertains to Austin, as we reviewed Austin, we felt that it was appropriate to bring in the same oversight people, Quintiles, into Austin in order to ensure that all the learnings we had at Rocky are actually in place in Austin. And so we are in that process right now, and as I mentioned, the FDA just came in the door at pretty much the same time. So we will get a read from the FDA as to how we're doing in our Rocky -- in our Austin plant, pardon me, as we move forward here. I will say we did have a meeting with the Dallas District that I also attended to talk about the Austin facility, and again, pretty much the same reactions we've had in the other meetings, which was, based on what we've said, it looks like good progress being made, but more needs to be done. And that's exactly the basis from which I say that I believe we're making good progress, but definitely, more needs to be done. In terms of moving forward then, so what do we see is the next kind of guidepost here? I really look at it as being the Rocky Mount inspection. We're anticipating that it should happen either later this year or early next year. And from my standpoint then, that will be an excellent view as to how exactly we're doing and are we turning the corner on our remediation efforts at Rocky. So my net-net here is the issues in the other plants are not to the same extent as Rocky. Rocky is simply a much bigger place. And I feel that we're getting our arms around it. We've identified the issues, and we're taking the appropriate action.

Operator

Your next question comes from the line of Marshall Urist with Morgan Stanley.

Marshall Urist - Morgan Stanley, Research Division

So I was just wondering if you could give us a little bit more granularity on sort of what increasing modestly means in the fourth quarter. So where would you right now, given your current plans, expect to exit the year sort of above that, relative to the 60% to 70% range, as we think about what the run rate into 2013 might look like? And then related to that, the third-party oversight expense does continue to increase sequentially. I think you've given us some color as to why that is, but maybe on the incremental profitability question, sort of where is your level of confidence in what the kind of base expense or sort of total quality expense that you're going to have to add into the business on sort of a permanent and ongoing basis really looks like? Or is that one area where it's still a work in progress in terms of what that's going to look like, and when do you think we will have sort of confidence on that front?

F. Michael Ball

Why don't I take the first one, and then, Tom, you take the second one there. So with respect to what do the modest increase look like, it's a slight increase over the 60% to 70%, where we are now. Marshall, I wish I could tell you this was an exact science. It just isn't. Our sense are, from the leading indicators, that things are trending up, that we believe the third quarter will be at the 60% to 70% range, but we see positive signs. So I can't tell you if that means 70% to 80%, but for assumption purposes, let's assume that we're moving over the 70% line, if that's a modest increase, up over at some end of that range. But we do not have precision on that, and I don't want to represent that we do.

Thomas E. Werner

And then, Marshall, on the second part of the question, I caught the end of it, which is the permanent costs to the quality system, but was there a first part to that second part of the question?

Marshall Urist - Morgan Stanley, Research Division

Yes, we keep seeing the sort of third-party oversight expense increased somewhat sequentially again, so I'm just trying to get a sense. I know you've talked about a number of ongoing initiatives, but just where are you guys in getting your hands around what that sort of permitting quality expense is going to look like as those third-party oversight gets converted into kind of permanent expenses? Kind of where are we in that process? And your confidence in what the final total amount will look like as we think about incremental profitability in '13 and after.

Thomas E. Werner

Yes, as far as the oversight, as Mike mentioned in his comments, we're going to begin ramping those down and shifting them to really completing the remediation activities and having oversight there. The premium on these people is pretty high, so when you look at what's being charged off into the onetime expense, it's quite a bit higher than the cost of what a normal full-time equivalent employee would bring on. What I said in the past in terms of permanent costs, we're at least looking at about 300 basis points of costs that's been added in so far. As far as what that's going to look like for next year, it's just a little bit too early to tell, but to date, it's somewhere between 250, 300 basis points of permanent costs -- permanent for the medium term. And as we get through the process of getting our 2013 budgets and plans put together, we'll have a better idea of whether we maintain at that level or can take some costs out or you have to slightly increase. It's just too early to tell.

Operator

Your next question is from the line of Greg Gilbert with Merrill Lynch.

Gregory B. Gilbert - BofA Merrill Lynch, Research Division

I have a couple. First, Tom, can you walk us through the $100 million change in cash flow outlook in some more detail? I heard you say operating income, but I assume there's some other things, too. And for Mike, it sounds like you're making really good progress with your team on the foundation fixes, but regarding the growth story ahead, can you provide a little more detail on your ex-U.S. filings, what plants they're being made from and when sales can really start to accelerate, at least conceptually? And as part of that, Sumant, can you update us on your biosimilar Herceptin program in light of the Watson and Amgen deal with Synthon?

F. Michael Ball

The reduction in cash flow, Greg, it's really 2 items. As we've taken a look at the earnings per share guidance in the comments we made towards the low end of the range, approximately $2, that's part of it. Also, the timing of the realization of the remediation onetime expenses, those expenses are happening sooner and earlier on than we originally forecasted, and that's cash. The rest of it's just a noise down on working capital, some back and forth, nothing really too significant individually. So I guess next one goes to Sumant.

Sumant Ramachandra

So just very quickly, the global expansion you were talking about and some of the new products in Europe, those programs have already started. Some of the submissions that we mentioned before have already started occurring. And as Mike mentioned in the prepared remarks, we are thinking approximately 50 submissions going in this year all though the globe, not all in Europe but in many parts of the world. That's going to rapidly accelerate over 2013, 2014. And these are just the initial series of molecules. We even haven't gotten into the second bucket of molecules that we want to get into just because of the amount of timing and resource it will take and the skills we need. So in terms of when they will get approval and our decision to launch, it depends on the country. Sometimes, it takes anywhere from 10 to 12 months in the fastest-moving countries, and sometimes, as you know in the U.S., it's sitting at 30 to 36 months. So it will be somewhere in that range, depending on approval. So that's how we want to get in these markets for submissions as fast as possible and accelerate our approval process with the health authorities as part of this process. So I can't tell you per molecule exactly when and where, but this process is moving very fast in the company. And as Mike has committed to, investments in this area, they are just starting to bear fruit in terms of submissions. Trastuzumab, Herceptin, as you mentioned, we are actually in this particular molecule in collaboration with Celltrion. Celltrion is involved in the development of this particular molecule, and they have, as they have mentioned previously, gone -- they're in the development phase in this particular molecule and will be ready for submission in the very near future. We won't comment on the submission date because we are depending on them on that particular dossier, but when they are ready, we are very closely collaborating with them. We will go through the process and submit our parallel dossier at that time.

Gregory B. Gilbert - BofA Merrill Lynch, Research Division

So you think you could be first globally?

Sumant Ramachandra

Could we be first globally? At this point, it looks like we are ahead of many people. I can't tell you whether we are first globally. We have mentioned about infliximab, okay, that submission had occurred both by Celltrion and by us. And in that situation, we believe that we are far ahead of the competition. We can't know absolutely for sure if we are first because health authorities do not tell us as to when this particular submission have gone and whether from competitors or our knowledge and whether we have -- when we submit either. What we know is our dossier.

Operator

Your next question comes from the line of Shibani Malhotra with RBC Capital.

Shibani Malhotra - RBC Capital Markets, LLC, Research Division

Mike, just another question on manufacturing. You said that you feel very positive about the progress. I just wanted to ask you based on how you are looking at things earlier on this year, are you incrementally more positive, more negative or kind of -- is everything going as planned in terms of the progress you are making? And then second, does it disadvantage you at all that you were working on Austin and the FDA just showed up, or is that just a nonevent? And then finally, on Rocky Mount, I guess what's the process for finding out whether the FDA has accepted your plan and what this means and how long it'll take for us to be updated?

F. Michael Ball

Okay. So as we go through and look at the year, so as I look at the year, and we're at the halfway point right now, and as I look out over the rest of the year, I think there's reason to be very pleased with how things are turning out. I mean, obviously, we've uncovered more issues. But as I said, the good news is the issues are manageable and were surfacing now. I believe we've done a nice job working constructively with the FDA, and they've done a nice job with us in terms of moving the whole remediation plan forward. And as I said in our meeting with them at the Center, they were pleased with our progress, pleased with our commitment to it, I think pleased with the investment that we are putting behind it and also, I think from a commitment standpoint, pleased that we weren't just going to the letter of the commitments, but we were going to the spirit of the commitments to get things done. So as I look at the number of inspections we've had recently, they are verifying that we are where we said we were, which is making progress but a ways to go. And so in terms of the Austin facility, obviously, you'd like more time, but they should go in there. They should see progress that we are making. And if we get the same result that we got in Clayton, I'll be satisfied. So as I move through the year, I'm looking at our global expansion. It really is getting legs, as Sumant said, 50 new-to-country submissions are going in the back half of this year, and we've got a ton more going in next year. Our biosimilars program is progressing. We've got EPO in the clinical trials. We have a path forward on biosimilars. We have infliximab submitted in Europe. So things are moving forward from that respect. As I look at Vizag, it's coming into view now in 2014, and that plant construction continues to go well. As I look at our new team -- and we brought in, just in the last few months, a new Chief Medical Officer, new Head of Regulatory, Head of Quality, Head of U.S. Ops, Head of Operations, Head of Devices, so I think we've transformed the team here into a team that can really move this company forward. So a very important point for us then and to answer your question on Rocky Mount, how will we know we'd get there, it's essentially with the FDA inspection, which I said I would anticipate at the end of the year, beginning of the year. And if we pass that test, then I think we can say we have satisfied the FDA and then we're, to use baseball parlance, we're tagging third and headed for home on reinforcing the foundation with our growth drivers as a company intact and having the opportunity to get supply going. Having said all that, we still have a lot to do in terms of the remediation work, and these expenses are more than we had originally anticipated. So as we work through the year, we can give you more color towards the end.

Shibani Malhotra - RBC Capital Markets, LLC, Research Division

Okay. But just to summarize so I'm clear, because you're giving us both sides of the sort of equation, which is clearly fair, you feel that versus your expectations of what would be required and how bad the situation is, you feel more positive in terms of the kind of progress you've made because regardless of new issues, you've made more progress than you'd thought on the kind of manufacturing side. Is that fair?

F. Michael Ball

I think that we have had hit a cadence as an organization that we expect the unexpected and we are able to manage the unexpected issues that are coming up with a very strong team and, I would say, a very constructive relationship with the FDA. And if that continues through the year, I will be very satisfied with the year.

Karen King

So we're at the top of the hour, and we're going to end the call. Thank you for joining us today. And operator, you can go ahead and disconnect.

Operator

This concludes Hospira's Second Quarter Conference Call. You may now disconnect.

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