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Hospira, Inc. (NYSE:HSP)

Q2 FY08 Earnings Call

August 6, 2008, 09:00 AM ET

Executives

Karen King - VP of IR

Christopher B. Begley - Chairman and CEO

Terrence C. Kearney - COO

Thomas E. Werner - Sr. VP, Finance, and CFO

Analysts

Danielle Antalffy - Leerink Swann

Frederick Wise - Leerink Swann

David Roman - Morgan Stanley

Taylor Harris - J.P. Morgan

Gregg Gilbert - Merrill Lynch

Junaid Husain - Soleil Securities Corporation

Operator

Good morning and welcome to Hospira's Second Quarter 2008 Earnings Conference Call. All lines have been placed on listen-only mode to prevent any background noise. Following the speakers' remarks, there will be a question-and-answer period.

I will now turn the call over to Karen King, Vice President of Investor Relations. Karen, you may begin your conference.

Karen King - Vice President of Investor Relations

Thank you. Good morning, everyone. Welcome to our conference call and webcast regarding Hospira's financial results for the second quarter of 2008. Participating in today's call are Chris Begley, Chairman and Chief Executive Officer of Hospira; Terry Kearney, Chief Operating Officer; and Tom Werner, Senior Vice President, Finance and Chief Financial Officer.

We'll 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 section in Hospira's latest annual report on Form 10-K and latest quarterly report on Form 10-Q 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.

In 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.

With that, I will now turn the call over to Chris.

Christopher B. Begley - Chairman and Chief Executive Officer

Thank you, Karen. Good morning, everyone and welcome to our second quarter call. During the quarter, we continued to advance the business as we focused on our strategic initiatives and positioned the company for a long-term growth. While we made progress on many fronts, our results were primarily impacted by one drug wholesaler's inventory destocking activity.

It is important to know that given our healthy year-to-date sales results, we increased our sales guidance and affirmed the top end of our adjusted earnings range. We are confident that we will achieve both our top and bottom line guidance for the year. As we walk you through our results today, we will share with you highlights of the quarter as well as our path to achieve our full year projections

Summing up the highlights of the quarter's achievements, Medication Management Systems showed significant progress during the quarter, with particularly strong growth in the Americas and Asia Pacific regions. Customer response to our recently launched Symbiq, the most technologically advanced infusion pump of its kind, continues to be very positive. This was evidenced by our strong placements during the quarter, the majority of which were competitive captures.

On the Specialty Injectables fronts, we introduced additional compounds from our on-market portfolio to countries around the world. During the quarter, we launched 12 compounds into new markets, brining the year-to date total of on-market launches to 23.

We continue to launch Retacrit, our first biosimilar and engineered version of erythropoietin in six additional countries in Europe. We made progress as well with our second biogeneric, filgrastim, known more commonly as G-CSF, as the Phase 3 clinical trials for the drug are continuing on.

Moving into integration. We integrated the remaining Mayne commercial operations to our SAP system. Completion of the SAP rollout is a milestone achievement and illustrates the tremendous progress we have made over the past 18 months in integrating the two companies. The combination of the two companies is meeting our expectations and added considerable value to Hospira making us a stronger global company.

As a result of the acquisition, Hospira is the world's leading generic injectible pharmaceutical company. We are leveraging our significantly expanded global presence to drive continued growth.

Finally, we continue to pay down the debt we took on with the Mayne acquisition. We are paying $60 million in the second quarter. This brings the total cumulative acquisition related debt we have repaid to $485 million.

We are also pleased to relay today that we were awarded contracts by Premier Purchasing Partners, one of the largest group purchasing organizations in the U.S. The multi-year contracts are for both I.V. solutions and Medication Management Systems and will take effect in our first quarter of 2009. The award represents our first contract opportunity in these product lines with Premier's broad membership, an important development for us.

We expect the Premier contract to drive benefits similar to what we have seen from our recent HealthTrust GPO pump and solution awards. Additional I.V. solutions share, competitive pump captures and increased specialty injectable volumes.

Before turning the call over to Terry, I want to touch briefly on two other topics; the economy and vancomycin competition.

Despite the slowing economy, we have only seen a modest impact to our sales, which has been primarily offset by market share gains. In addition, we are seeing some adverse effect in commodity and fuel cost. We are taking a variety of internal steps where possible to mitigate the impact and are evaluating a number of external options. We realize the U.S. economic condition is something we cannot take lightly and we'll continue to monitor the situation closely.

As many of you know, last month there was news that an additional competitor had obtained FDA approval to sell vancomycin, our largest selling drug in the U.S. Knowing that more competition could enter the market, we have been active in our efforts to secure our position and protect our leading share. We have strong positions on GPO contracts, multiple presentations of the drug, including a proprietary delivery format and an unparalleled reputation for quality and reliability with this product.

As a result, we don't expect the competitive entry to have much, if any, financial impact at Hospira in 2008. Longer term, we will continue to aggressively defend our position and are confident that we can achieve our financial goals for 2008 and beyond. In fact, our goals have always assumed competition by 2009.

And now Terry will provide some additional detail on the quarter. Terry?

Terrence C. Kearney - Chief Operating Officer

Thank you, Chris and good morning every one. As I take you through the highlights of each of our geographic segments, I will be referring to net sales increases or decreases for the second quarter and year-to-date on a constant currency basis. That is, excluding the impact of foreign currency fluctuations. There is a table accompanying our press release to help you better understand the impact of foreign currency by segment and product line.

In addition, I will be referring to 2008 full your projections during my comments. Since we received a benefit from foreign exchange in the first half of the year, we have updated our annual projections to include the anticipated impact of foreign currency. I will focus most of my comments on the Americas or performances driven by the U.S.

Net sales in the Americas were up 1% for the quarter and up 4% year-to-date. For the quarter, strong performance in Medication Management Systems was offset by softness in pharma. Specialty injectables were down 1% for the quarter, primarily driven by significant inventory destocking by one of our major wholesalers following strong purchasing patterns in both of fourth quarter of 2007 and the first quarter of 2008.

The burn off of inventory became evident in May and carry through to the end of June. We estimate that destocking impact on sales in the quarter was approximately $20 million. We've been in dialogue with this wholesaler and we are informed that they expect it to return to normal purchasing patterns in July. We have monitored their purchases through July and they have returned to more normal purchasing volumes.

It is important to know we have analyzed all of our major wholesalers and currently we do not see any unusual purchasing patterns with the others. On a year-to-date basis, specialty injectable sales growth is meeting our projections. There is a good deal of underlying strength in SIP. We are experiencing growth in excess of the market, driven by solid increases in our base business coupled with share gains from our recent GPO pharmacy awards.

On a full year basis, we expect Americas SIP sales to grow between 9% and 11%, which includes the impact of foreign currency. As we have historically witnessed, our second half of the year is stronger than our first half. The acceleration in the second half will be driven by normalization of wholesaler purchases, continued base business growth coupled with increased volumes from our recent pharmacy awards and new product sales.

The most significant new product launch planned in the second half is piperacillin, tazobactam, or Zosyn. We are forecasting approval and launch late in Q3. Our partner on this drug has indicated that the FDA's ANDA review is progressing with most, if not all, outstanding issues being addressed. In addition to Zosyn, we also are on track to launch azithromycin and rocuronium.

Moving to other pharma, we are achieving double-digit growth in our large volumes solutions business, reflecting share captured with our new GPO award as well as strong demand for our VisIV products. Strategically, a larger I.V. footprint will pull through additional higher margins specialty injectables and medication management system sales.

Contract manufacturing sales were down for the quarter, reflecting reduced demand by some customers. We expect to see a slight rebound in the second half of the year.

Medication Management System sales in Americas increased 20% during the quarter, reflecting strong pump placements in particular of Symbiq as well as our improvements in our implementation processes. Interest in Symbiq continues to build. Placements in the second quarter more than tripled compared to the first quarter of 2008. Furthermore, over 90% of Symbiq placements in the quarter were competitive captures, leading to increased market share. We are pleased with the strong market interest and momentum we're seeing with Symbiq.

Placements of Plum A+ and LifeCare PCA also grew at double-digit rates in the quarter. MMS will be an important contributor to our growth in 2008, driven by the continued penetration of Symbiq, as well as account gains from our recent HPG award. We are projecting full year sales growth including impact of foreign currency of 13% to 16%. We expect this momentum to continue into 2009 aided by the additional benefit from our new award position at Premier.

Turning to the European region, overall sales were down 4% in the quarter, but up 6% on a year-to-date basis. Sales of specialty injectables were flat for the quarter, with solid volume growth across many of our key molecules, while prices declined in line with the market. Fundamentally, nothing has changed. You may recall when we provided 2008 sales projections in February, we forecasted limited growth, given our modestly product launch schedule in 2008, and expected declining market prices.

As I have also mentioned before, while our prices tend to decline year-over-year, product margins still remain robust. We continue to roll out Retacrit, our first biosimilar product across Europe. In the quarter, we launched Retacrit in six additional markets; United Kingdom, Ireland, Portugal, Sweden, Norway, and Greece. This brings a total year-to-date country launches to eight.

We are encouraged by the recent momentum we are seeing in Germany, where we've been on the market the longest, since our January launch. It appears biosimilars are gaining wider acceptance despite the efforts of the innovators to protect their market shares.

We will continue to rollout Retacrit in several additional European countries throughout the remainder of this year and into early next year. On a full year basis, we expect SIP in Europe to grow between 15% to 20% which includes the impact of foreign currency.

In Medication Management Systems, sales were down 2% for the quarter but up 4% year-to-date. We have seen slower uptake for our general infusion pumps but strong demand for GemStar are ambulatory pump. We are expecting a stronger second half with higher general infusion pump placements supported by additional language translations.

In the second quarter, we launched three additional language translations to the European market. For the year, we are projecting MMS sales growth for Europe to be in a range of 20% to 25%, again including foreign exchange.

Asia Pacific sales were down 2% in the quarter, but up 11% on a year-to-date basis. Specialty injectables were up 1% in the quarter while year-to-date were up 15%. On a full year's basis, we expect to grow between 25% and 30%, including the impact of foreign currency, primarily driven by higher sales in Australia and Japan in the back half of the year.

Medication Management Systems growth was 13% for the quarter and 18% year-to-date, driven by strong placements at Hong Kong and Taiwan. We are forecasting sales growth for the year to be in the range of 30% to 35% including the impact of foreign currency, driven by stronger device sales in Australia.

Finally, before I turn the call over to Tom, I wanted to provide a little more color on the comment Chris made earlier regarding the completion of the rollout of our SAP platform across the former Mayne entities. We did complete the rollout at the beginning of July on time with minimal disruptions to customers. The roll out went very smoothly and I would like to recognize the time and expertise that many employees from around the world put in to this effort. We greatly appreciate their dedication and commitment to making this a successful project. With the rollout of SAP now completed, we will turn our attention to a few remaining integration projects which we expect to complete before year end.

I'll now turn the call over to Tom.

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

Thanks, Terry and good morning everyone. Net sales in the second quarter were $902 million, a 4% increase over the last year, with foreign currency being a major contributor. Year-to-date sales were up over 8% with constant currency growth at 5%. Adjusted gross margin in the quarter was 39.6% compared to 37.8% in the second quarter of 2007. Improved manufacturing performance drove the increase and more than offset higher freight and distribution expenses.

Adjusted R&D expenses were $57 million in the quarter compared with $52 million last year, an increase of 10%. The increase was driven by higher investment in our drug development activities as well as a 4% impact of foreign exchange. Adjusted R&D as a percentage of sales was 6.4% versus 6.0% in the same period of 2007.

Adjusted SG&A expenses for the second quarter were $148 million compared to $137 million last year, an increase of 8%. The increase was primarily a result of the investments in the business particularly the launch of Retacrit in Europe and commercial development in APAC, also a 4% impact of foreign currency.

Adjusted SG&A as a percentage of sales was 16.4% versus 15.8% in 2007. Adjusted operating income for the quarter was $152 million versus $139 million last year. Adjusted operating margin was 16.9% compared to 16.0% last year.

Adjusted interest expense declined 24% to $28 million in the second quarter from $37 million last year, reflecting our continuing pay down of the Mayne acquisition related debt. Although the other income net line, which includes interest income and miscellaneous items such as foreign exchange, transaction gains and losses was nil for the quarter, it was down $5 million from the second quarter of last year, due to lower interest rates and cash balances as well as some foreign exchange transaction gains in the prior year.

Our tax rate on an adjusted basis in the quarter was consistent with our full year projected rate of approximately 25.5%. And our adjusted diluted EPS for the second quarter was $0.57 compared to $0.49 last year. Our second quarter adjusted diluted EPS excludes several items relating to main and other acquisitions as well as to our facilities optimization initiatives. The acquisition related expenses are as follows. First, non-cash pre-tax charges of $16 million for the amortization of intangibles related to Mayne; second, $8 million of integration costs that were primarily cash. Together, these acquisition-related items represent $0.10 in the GAAP diluted EPS in the quarter.

Expenses related to our facilities optimization initiatives totaled $10 million pre-tax or $0.04 per diluted share. On a cash flow statement, our cash flow from operations for the quarter was $109 million compared to $122 million in the second quarter last year with the difference mostly related to plant increases and inventory to both satisfy increased demand and to prepare for new product introductions. As a result, inventory turns decreased slightly from Q1 levels.

Day sales outstanding compared to the first quarter of this year, increased a few days. Capital spending in the quarter was $44 million, depreciation and amortization was $64 million in the quarter including $16 million of intangibles amortization related to the Mayne acquisition.

As Chris mentioned, we also paid down an additional $60 million of our debt in Q2 bringing the year-to-date repayment total to $85 million, and we continue to target repayment of $475 million of our debt in 2008, with the majority to be paid in the fourth quarter.

Now turning to guidance and projections. Regarding our projections for the 2008 year, we are increasing our net sales guidance to reflect the impact of foreign currency and we are narrowing our EPS range to the upper end of our previously disclosed guidance.

We expect consolidated net sales growth of 8% to 10% including the impact of foreign currency, which we estimate will be a benefit of about 2%. We are projecting sales growth in the Americas to range between 6% and 8%, and as Chris stated, for specialty injectables, we are assuming no material impact from increased competition on our expected vancomycin sales this year.

In the European segment, we expect sales growth to range between 8% and 11% and for Asia Pacific, we expect sales growth for this segment to be between 24% and 28%.

Now our previously disclosed assumptions for adjusted gross margin, R&D, SG&A, and operating profit as a percentage of sales remain unchanged. As a reminder, we expect adjusted gross margin to be between 39% and 39.5%, R&D between 5.8% and 6.1%, and SG&A between 15.3% and 15.8% of sales.

Below the operating line, we are forecasting net interest expense and non-operating items in the aggregate to be in the $105 million to $110 million range.

In terms of calendarization for the second half of the year, we continue to expect Q4's diluted earnings per share to be the highest for the year with Q3 higher than Q2s adjusted EPS. The guidance translates into a 2008 adjusted diluted earnings per share in the $2.50 and $2.55 range. This implies year-over-year growth of 14% to 16%.

Based on our earnings to-date, we expect to see back half adjusted diluted EPS of $1.38 to $1.43. We know this translates into significant growth from the first half to the second half of the year. Let me outline for you, the major drivers and broad ranges of EPS contribution that enable us to reach our full year EPS projections.

The major drivers of the increased earnings in the second half of the year are first, strong new product growth contributing between $0.5 and $0.10. Second, increase in the pharmaceutical base business including Precedex, resumption of normal wholesaler buying patterns, and last, new GPO pharmacy awards. We expect this to contribute potentially $0.10 to $0.15. And lastly, higher MMS sales including related sets and services contributing between $0.05 and $0.10.

Our estimates for cash flow from operations and capital spending haven't changed. Cash flow from operations is still expected to be between $575 million and $625 million and capital spending between $190 million and $210 million.

Depreciation and amortization is now projected to be between $190 million and $200 million and that does exclude the amortization related to Mayne. With that, I will turn the call back to Chris.

Christopher B. Begley - Chairman and Chief Executive Officer

Despite the slowing U.S. economy and the wholesaler inventory destocking we encountered during the quarter, we remain comfortable with and committed to our sales and earnings guidance. We increased the overall sales guidance to reflect the benefit from foreign currency and narrowed our adjusted diluted EPS guidance to the top end of our prior range.

Year-to-date U.S. MMS and SIP revenues are increasing at our forecasted levels of growth. We are confident in our updated projections. Let me reiterate to you the drivers that will allow us to deliver projected growth in the second half of the year. Gaining SIP market share with new products and new broader GPO awards, increasing MMS momentum via increased GPO access and Symbiq penetration, implementing programs to mitigate higher commodity and fuel cost and seeing the wholesaler purchasing patterns returned to normal levels.

The organization is high focused on delivering EPS in the $2.50 to $2.55 range while building a business to consistently deliver our goals. And now operator, we are ready to take questions.

Question And Answer

Operator

[Operator Instructions]. Please limit your question per two per person. If you have additional question you may re-enter the queue. Your first question from the line of Rick Wise.

Christopher B. Begley - Chairman and Chief Executive Officer

Good morning, Rick. I think we lost Rick.

Operator

Would you let me to go to the next question sir?

Christopher B. Begley - Chairman and Chief Executive Officer

I think that would be appropriate.

Danielle Antalffy - Leerink Swann

Hey guys. Yes, sorry, this is Danielle in for Rick, how are you?

Christopher B. Begley - Chairman and Chief Executive Officer

Good. How about yourself?

Danielle Antalffy - Leerink Swann

Good, thanks. Sorry, he is traveling today. So my first question is regarding sales growth guidance. You guys raised guidance, but it now includes FX. You estimated 2% impact from FX. So is it fair to say that despite the vanco competition which you talked about and despite a somewhat delayed dosing in launch that you are expecting organic sales growth guidance still in the prior 6% to 8% range?

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

That's correct, Daniel.

Danielle Antalffy - Leerink Swann

Okay. So, I am just trying to get a better understanding of what's going to be driving that. I mean, so you missed our sales estimate for this quarter and consensus, are you looking for... is it going to be better Med Management Sales, is it going to be better specialty injectables sales versus what you were expecting before, I guess is what I am trying to get a sense of.

Christopher B. Begley - Chairman and Chief Executive Officer

Well, let me see if I can help you with that Danielle. Again the issue in the second quarter was the stocking, the unexpected destocking by one of our wholesalers and as we look into the future for the next six months, we expect the wholesaler buying patterns to normalize. So, that will part of the impact as far as growth in the second half versus the first half. In addition, from our SAP perspective, we will see added volume gains based on our new expanded GPO pharmacy awards, which went into effect in late April, early May. So there is going to be some pull through in the second half of that.

And we will continue see good growth in our base business. We have talked about in prior quarters, some of that growth is coming from just PURE basements of growth and driving the promotion of our products, but also from competitors not able to supply the markets. So we continue to see some of that benefit. And finally with new products, which we mentioned is also being one of them but we have other have a number that we'll we launching in the second half of the year. So that's all striving SIP and quite frankly from an MMS perspective, it is all about Symbiq and momentum we've seen with Symbiq and we believe that growth will continue through the second half of the year.

Frederick Wise - Leerink Swann

If I could jump in, I think... I think my technology [indescribable] guys. Good morning.

Christopher B. Begley - Chairman and Chief Executive Officer

Good morning, Rick

Frederick Wise - Leerink Swann

Let me touch on the Premier contract. Maybe just a couple of questions in one. Just remind us what you think you can do with Premier contract that you couldn't do before, concrete steps that you are going to take to realize that potential and maybe comparing to press, what you did at HealthTrust with a contract in hand again versus without and how we might read through to the impact from premier. Thanks a lot.

Christopher B. Begley - Chairman and Chief Executive Officer

Rick that's a lot let me start out with that and then I'd ask Terry to chime in and fill in any gaps that I may leave. First of all, in the Premier award, it's effective February of 2009 and it is a 5-year contract and we really believe it's going to be a big opportunity for MMS business since we've not had access from an MMS or an I.V. standpoint with Premier. The other thing to frame for you is Premier consist of about 2000 member hospitals to give you the size of the organization, there is roughly about 5000 hospitals in the U.S. and they represent 2000. And so we really do expect to gain share from Premier accounts on both MMS and from an I.V. standpoint and then there also be a trickle over impact into SIP as well.

And so we see this as a very good opportunity for us moving forward. Kind of put in perspective with HPG, with HPG which we were awarded earlier in the year, we gained roughly 200 hospitals to-date that we have converted from an I.V. standpoint and then we are in the process now of bringing in our MMS product line and also beginning to see some increased SIP business. And so you know one could anticipate we would do as well a Premier or perhaps even better.

Frederick Wise - Leerink Swann

Thank you so much.

Christopher B. Begley - Chairman and Chief Executive Officer

Next caller?

Operator

The next question comes from David Roman.

David Roman - Morgan Stanley

Good morning. It's David Roman from Morgan Stanley. How are you?

Christopher B. Begley - Chairman and Chief Executive Officer

Good, Dave. How about yourself?

David Roman - Morgan Stanley

Good, thank you. Just a couple of points of clarification. On the $20 million of destock in the quarter, did you mention that was on one product or that was on a series of products?

Terrence C. Kearney - Chief Operating Officer

Dave, that was across a series of products that particular wholesaler buys from us.

David Roman - Morgan Stanley

Okay, so fair to think like a quarterly run rate for... from that wholesaler normalized is going to be in the $30 million to $40 million range?

Christopher B. Begley - Chairman and Chief Executive Officer

No, as I mentioned to you, it was started it became evident in May so wasn't necessary across the full quarter.

David Roman - Morgan Stanley

Okay, but I am just trying to get a run rate for that order, those ordering patterns so started at the end of May, it's like a six-week impact right, or may be double that for the quarter, is what a normal ordering pattern would be from this customer?

Terrence C. Kearney - Chief Operating Officer

You know, we really haven't in the past really talked about specific ordering patterns by anyone of our wholesalers, so I am not sure if that's a place we want to talk to right now.

David Roman - Morgan Stanley

Okay. And then on the gross margin improvement year-over-year, can you maybe just quantify the pieces of improvement. You mentioned manufacturing being a big piece of that, but maybe you could give us the positive and negative contributions and what did freight and commodity cost knock off gross margin improvement, and how is that offset?

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

Yes, David it is Tom. Good morning. Freight and distribution 20 to 30 basis points off, but strong performance in the factories, cost reductions and then good volumes more than offset that, but it's basically a manufacturing and distribution story, and that's about it.

David Roman - Morgan Stanley

Okay. And then you mentioned last year your expectations for the impact, the additional comparison in vancomycin haven't changed. Can you just remind us what those expectations are for the full year?

Christopher B. Begley - Chairman and Chief Executive Officer

On vanco, as we said in our opening comments, there is another competitor on vancomycin and we don't see that impacting our financials in 2008 and for our 2008 and beyond goals that we have always talked about, we have always factored in that we would have competition on vancomycin in 2009. And so that's what we made in our opening comments and we don't see that deviating at this point in time.

David Roman - Morgan Stanley

Okay. Thank you very much.

Christopher B. Begley - Chairman and Chief Executive Officer

Thanks, David.

Operator

Your next question comes from Taylor Harris. Your line is open.

Taylor Harris - J.P. Morgan

Thank a lot guys. So my question is on gross margin for the full year. It looks as though you are expecting a much stronger year-over-year improvement in gross margin in the second half of the year than you had in the first half. So what are the factors leading to that view?

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

Hi Taylor, it's Tom. Typically, in the back part of the year, we do experience the factory shutdowns, which have some depressing impact on margins. But overall, it's going to be stronger product mix in the back part of the year and the factories will continue to run at good activity levels even with the shutdowns.

So, look at margins last year, Q3 was sort of equal low point with Q2 of last year, 37.8, Q4 at 38.4. So, we just expect that continued cost reductions, good volume, and a little bit stronger mix in the back part of year will all contribute to better margins.

Taylor Harris - J.P. Morgan

Okay. As we think about gross margin, how much... how important is volume gains there I guess relative to some of the other factors like product mix, mix toward med management, et cetera.

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

The volume is serving a minor impact; it's much more cost reductions and then product mix.

Taylor Harris - J.P. Morgan

Okay, very good. And then just walk us through the narrowing of the EPS range to the high end of your previous range. So is there... it sounds like organic sales growth is unchanged. So is there an FX benefit that's dropping through to the bottom line that helps you with earnings or what else leads to that uptick?

Terrence C. Kearney - Chief Operating Officer

Taylor, that's kind of the short story there. There are some puts and takes within the various product lines, we have adjusted some of the guidance as you are probably familiar at this time of the year. We go through a pretty exhaustive re-plan which we call the update and we've really touch to looked that all the drivers for the business in the back part of the year. So as we've gone through that, there have been some puts and takes. MMS for instance in the U.S., we've taken the growth up there, given the strong performance we have seen so far. But overall, it is FX and for the quarter, we probably saw $0.02 to $0.03 FX impact, we saw little bit less than that in the first quarter. We don't expect FX to have much of an impact at all in the back part of the year as you probably know, the rates last year really strengthened against the dollar primarily in the first half and assuming the rates stayed fairly stable we don't expect to see much FX in the back half of the year, so it doesn't quite translate to a full year impact of what we already seen at half the rate because the sales are little bit larger in the back part. But that's kind of the story, it's FX.

Taylor Harris - J.P. Morgan

Okay. And just one final question. Vancomycin, certainly the competitor entered the market is a small competitor and so just curious would your thought from the outlook for vancomycin change if you had a series of larger competitors enter that business or is the dynamic really more a contracting cost position, one that where you feel like you are immune to competitors no matter what the size?

Christopher B. Begley - Chairman and Chief Executive Officer

Taylor, this is Chris. It's more of a contracting cost situation. Obviously, the more competitors are in a market, the additional price pressures that will exist, but keep in mind typically have competitors have been fall out of bed too. And so it's more of a contracting cost position and the fact that we are really good at making vancomycin from a quality standpoint, from a service standpoint, plus we have roughly 20%, 25% in a unique proprietary patent protected delivery form that makes a whole lot of sense in reducing waste and reducing labor for our hospital customers.

Terrence C. Kearney - Chief Operating Officer

And Taylor, I would add that again it really comes down to the type of competitor, if it's a competitor that's relying on third party manufacturers for API finished, we would anticipate they have less wiggle room to take price and they probably would end up being more rational from a pricing perspective. Also, they also would depend on their ability to supply the market i.e. the capacity that they can bring to the market, will play a significant role and whether or not they make any headway. And I think as Chris just said, the customers are going to have to get comfortable with any new entrants, being able to supply quality product and in a very reliable manner to what they currently used to with Hospira. So, we think we are well positioned with vancomycin.

Taylor Harris - J.P. Morgan

Okay. And, maybe just one final, is your cost position on the bulk active vanco secure at the current level for a while or does that change contractually at some point?

Terrence C. Kearney - Chief Operating Officer

We're pretty secure.

Taylor Harris - J.P. Morgan

Okay.

Christopher B. Begley - Chairman and Chief Executive Officer

And, we are always trying to make improvements on the cost side, whether it's through the bulk drug or through what we're driving as far as efficiencies with our six sigma program and our manufacturing operations.

Taylor Harris - J.P. Morgan

Okay. Thank you, guys.

Christopher B. Begley - Chairman and Chief Executive Officer

Thank you, Taylor.

Operator

Your next question comes from Gregg Gilbert.

Christopher B. Begley - Chairman and Chief Executive Officer

Good morning. Gregg.

Gregg Gilbert - Merrill Lynch

Thanks. Good morning, guys. Going back to the wholesaler buying patterns for SIP, just looking back in Q1 sales versus IMS, I realized this isn't a scientific exercise necessarily. But it did look like some level of destocking to be in order for the second quarter. So I wanted to just drill that a little more into what was surprising about the destocking? And I guess the bigger picture question is how do you assess what inventory levels are at a given point in time and sort of what's ideal?

Terrence C. Kearney - Chief Operating Officer

Well, I guess as you go back to what we talked about in the first quarter, there is a lot of activity that was going on in the marketplace at that point in time. We were seeing share gains, good solid base business growth as well as what we thought were stronger buying and purchasing patterns due to the flu season. So that's what we attributed the growth to, at that time if you may remember. It really wasn't evident as we were monitoring the sales evolution into the second quarter, really did not become evident that there was those any significant fall off until we completed the call, maybe a week or so later that when we starting to look at trends and May was starting to look a little softer, it became evident that something was happening in the marketplace and that's where we reached out to... we did our analysis, and we reached out to that particular wholesaler to find out little bit more about what was happening.

And again they informed us that they would be lowering inventory levels through the remainder of the quarter and resuming normal purchase patterns into July, which they have done. Relative to how we are going to manage this and look at it going forward, certainly we are going to, you can clearly expect us to be on top of the purchases wholesalers are making. It's not going to be real easy to fully understand their inventory levels at this point in time but we will continue to engage them and dialog with them and try to find out what additional information we can gain from them relative to better understanding those wholesaler inventory levels throughout any one quarter. But again, I think there is little bit more work to be done there.

Christopher B. Begley - Chairman and Chief Executive Officer

Greg, the only other thing I would add to Terry's comments is the following. Keep in mind that we've got the broadest line of generic injectables in the U.S. from our list number standpoint, delivery systems et cetera. So you are talking about a large scale that runs through all the different drug wholesalers and it's impossible for us to predict any share shifting that may be occurring between the drug wholesalers as well. And so that's another piece that ends up masking the activity between the major drug wholesalers.

Gregg Gilbert - Merrill Lynch

Thanks. My second question and then I'll get back in line is Chris, what are your high level thoughts on Fresenius APP combination and what that means for Hospira sort of near term and long-term? Thanks.

Christopher B. Begley - Chairman and Chief Executive Officer

Obviously, Fresenius buying APP, for some of us really was not a surprise. We know that Fresenius has been looking for some type of U.S. channel play and also know that from a competitive standpoint that outside the U.S. the generic injectables space is a space that they are very intrigued by and have begun to develop with some other small acquisitions. You know short term; we don't see it as an impact whatsoever. In fact one could argue when you are acquired by another company integration process is key, and if you don't do it right, you tend to lose your focus. And so it may actually present an opportunity for us in the short term.

I think the other key piece to keep in mind is part of this strategy which one could believe it is to take and sell their products through the APP channel in the U.S. longer term. We have a lot of experience with that activity with our Mayne acquisition, and I will tell you what, it is not easy to take a product offering in one country and bring it into other countries. It's very time consuming. The filings need to be quite often updated or changed for different test methods and so it is a long process and one that has a lot of issues to it.

And so, I think, longer term, there is this U.S. channel play. I think that will be a long-term and uphill battle and we believe that we are ready to compete with them and we like competing with other competitors and we think bottom line, we will end up being successful, because we are still going to drive innovation as it relates to the specialty injectable product line and MMS product line. And we believe that we understand the U.S. market better than any of our competitors and we will continue to bring out innovative products that meet their needs.

Gregg Gilbert - Merrill Lynch

Thank you.

Operator

Your next question comes from Junaid Husain, the line is open.

Junaid Husain - Soleil Securities Corporation

Good morning, gentlemen. How are you doing?

Christopher B. Begley - Chairman and Chief Executive Officer

Junaid, good morning.

Junaid Husain - Soleil Securities Corporation

On the Premier contract, if I could push you a bit more on this, could you tell us who else was awarded on the Premier contract for I.V. therapy to the extend that you know the incumbent on the contract state of the contract?

Christopher B. Begley - Chairman and Chief Executive Officer

Junaid, this is Chris. Other than what we've covered, I cannot go any further about talking about Premier. Out of respect for Premier, they are in the process of launching this with all of their hospitals, and so it would be inappropriate for me to start talking about anything other than what I have already covered with you on the call, which was cleared by and with Premier okay. Sorry.

Junaid Husain - Soleil Securities Corporation

Fair enough. And then actually to Tom, the R&D spending was a tint high than I was modeling. I was wondering if you could just walk me through where the majority of the spent is going? I know, you have a bunch of initiatives ongoing with clinical trails for biologics and Precedex et cetera but if you could help me out in terms of what the spent is going?

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

There is really nothing singularly pronounced there. Year-over-year, it's just a variety of projects within R&D. We are spending... versus last year we are spending little bit more on Precedex. GCSS down a little bit from prior year. It's just variety of back and forth and no one driver.

Christopher B. Begley - Chairman and Chief Executive Officer

We also have FX playing through R&D line about 4%, so you got to factor that in as well as on the SG&A line.

Junaid Husain - Soleil Securities Corporation

Got you. And then Tom or Terry, can you remind me in R&D, does that include regulatory expenses for filing dockets with various geographies?

Terrence C. Kearney - Chief Operating Officer

It does.

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

Yes.

Junaid Husain - Soleil Securities Corporation

Okay. And then last question for Tom, more housekeeping on your other income line, it was nil for the quarters so how should we be thinking about this on a go-forward basis?

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

I think the assumption is to probably keep it at where it is at for the quarter. I think if you take... I kind of look at interest expense and the net other together and we could probably assume a slightly less run rate for the back two quarters of the year. I think together that was about $28 million and we will have some benefit of debt pay down, but not a tremendous amount. Given what goes on in other net, we've got some varying items there including interest income. I don't expect it to be much different in the next two quarters.

Junaid Husain - Soleil Securities Corporation

Fair enough, that's all I got. Thanks guys.

Christopher B. Begley - Chairman and Chief Executive Officer

Thank you, have a good day.

Operator

Your next question comes from the line of Rick Wise. The line is open.

Frederick Wise - Leerink Swann

Hey,trying to... just a couple of follow-up questions, if I could guys. First one, Chris, can you give us a little more color on the Retacrit performance. You were talking about specifically in Germany; it was going better than you had thought. Maybe can you quantify, you know the dollar contribution in the quarter or some perspective on what it might contribute this year? And I know you're sort of reinvesting that money in building on the sales force, when does it start to make a profit contribution? Thank you.

Terrence C. Kearney - Chief Operating Officer

Rick, this is Terry. Let me see if I can take a stab at that and again if Chris has anything to add, he certainly will. I think we have to put this in perspective. When we launched Retacrit earlier this year, we knew that it would be a year where we're just starting to build momentum because we weren't going to be able to launch in every single European country immediately based on our ability to gain pricing approvals. So, it's been a rollout process as you know throughout the year will continue to do that through, the remainder of 2008 and then to early 2009. So, really what we are trying to accomplish in 2008 is really just to start to broaden the awareness, understand the competitive response and be able to adequately address that response. So, our expectations for 2008 weren't very high and again with the investment mode, with the sales force and the promotional expenditures related to this new product launch, you are absolutely correct, we weren't currently making a lot of money actually prior... more of an investment node as we have indicated before.

So it's not a significant contributor to growth in this year. We do expect the sale forces will be pretty much in place by the end of the year and we expect to be able to leverage that investment going into 2009. And again, the good news being, as we mentioned with Germany is that, we've been in that market for about six months and the initial going was somewhat slow, and it's a market that's characterize by not only having innovators present but also number of generic competitors as well. So it's a fairly crowded market, but we are starting to see some good traction in Germany. And again, I think it's more of the German customer becoming more aware and more comfortable with the concept of biosimilars and their willingness to use them and their ability to better understand the clinical data that we have provided to them.

So, I think that's a positive and we are expecting that same process will unfold in the other European markets once we have timing market and opportunities to promote the product and to continue to grow the business, so, again not a lot to expect in 2008, more to come in 2009.

Frederick Wise - Leerink Swann

Very helpful. And one more follow-up, on med management, you emphasized several times that you are seeing very strong U.S. business because of competitive gains. Again, can you give us a little more color on that and I mean, is it a particular type of account, is it against a particular type of one of the two major competitors again, just any more detail would be very much appreciated. Thank you.

Terrence C. Kearney - Chief Operating Officer

Well, let me again try to respond to that. From the day we initiated the broad launch soon back in the beginning of this year, our intent from a promotional and market strategies, always to go after competitive accounts. We believe we have the technology to do that and again the second quarter results certainly reflect the fact that we are doing very well in taking away competitive accounts with Symbiq and the technology is very well received.

As far as the type of account and so forth, it runs sort of... but typically it's the leading institutions if you will who are looking for the latest and best technology, the most technologically advanced, the technology is based on human factors that wins a lot of interest and praise from our new customers. So it does run across the continuum of different types of customers and then different competitive bases.

Christopher B. Begley - Chairman and Chief Executive Officer

Rick, this is Chris. And the only thing I think I would add to that is, we obviously with new presence on GPO contracts, we are seeing market share gains associated with those GPO contracts. And we are seeing that both on our Plum A+ and Symbiq and from a Symbiq standpoint to Terry's point, we are seeing children's hospitals adopting the technology, we are seeing large integrated systems adopting the technology and then we are also seeing smaller hospitals focusing on the technology as well. So, we really think we have a winner for overall for the U.S. market no matter what type of hospital it may be.

Frederick Wise - Leerink Swann

That's very helpful. Thanks so much Chris.

Operator

Your next question comes from Gregg Gilbert, the line is open.

Gregg Gilbert - Merrill Lynch

Hi, I was wondering if you can provide anymore quantitative color than you did on the Symbiq sales and how you plan to speak to that going forward, perhaps as a percentage of the segment or any other metrics you can provide there, sounds like it's going well?

Terrence C. Kearney - Chief Operating Officer

Again Gregg, Symbiq is going is very well, but it's not the only product we offer to our customers in the marketplace. As we mentioned, we also had very good growth for both our Plum product line as well as our LifeCare PCA product line. So our team is going out and promoting the full range of infusion technology and again based on the type of customer we're promoting to and talking to, their decision may very because of maybe a difference in technology they are looking for or price points in that. Again, we believe that it's nor just any one singular device and particular Symbiq, Symbiq has certainly energized the sales force but we believe it's the full offering that we provide to our customers that's really driving growth.

Gregg Gilbert - Merrill Lynch

And Chris going back to your comment in the prepared remarks regarding market share gains offsetting an economic impact, what's the core to this statement on the economic impact that you are seeing some. Can you give us a little more color as to what you're seeing there and whether it's anecdotal or otherwise? Thanks.

Christopher B. Begley - Chairman and Chief Executive Officer

Yes. It's more anecdotal than it is analytical in nature. And I'll give you a couple of data points. First of all, the way the U.S. economy is, I think it would be unrealistic not to think or assume that elective procedures are being postponed in some areas, okay. Whether as because people have lost their jobs, and they have lost insurance coverage or they are afraid of going in and having a arthroscopy done because they don't want to lose their job and take the time off from work.

Having said that though, that is a very small, small piece of our overall business and it's in that -- when I go out and talk to customers, which I have spent a lot of time in past several weeks, it's not a consistent theme from integrated system to integrated system. Again I think there is pockets in this country that have been hit harder. And so we are seeing a little bit of elective surgeries postponed. And where we see it is in the I.V. solution piece and keep in mind, typically when you go into a hospital in U.S. every patient gets put on an I.V. bag and so we have some fairly good visibility into what's happening, at an account level.

And as Terry talked about, our I.V. business in the U.S. is growing double-digit that's due to this I.V. and market share gains that we've made, so it's growing very, very nicely. But in some of our base business and again in certain locations in the country, we've seen a little bit of a drop and that's tied to elective surgeries but nothing to be overly concerned about at all.

Terrence C. Kearney - Chief Operating Officer

Generally, the census beds and when we talk to our customers they say that there really hasn't been a whole lot of change in census beds so that's a positive still.

Gregg Gilbert - Merrill Lynch

Just to be clear there, you haven't really seen that financial health of the hospital themselves being an issue in terms of them selecting a Ford instead of a Cadillac for example?

Christopher B. Begley - Chairman and Chief Executive Officer

No, we have not, and in fact in a couple of visits I was making last week, I was talking to some hospital CEOs and CEOs of integrated systems and even their collections haven't been impact that from their patients either. And so, the data is somewhat inconsistent and I guess what it further points to is this healthcare industry is a fairly stable industry especially when you are associated with products like we have that are mainly acute care procedures. And if some one needs to have open heart procedure done or a neurosurgery procedure done, they are going to go in and get it taken care of. And so, as we've said before, it looks pretty depression resistant to this point in time. But it's the elective procedures where we have seen a little bit of a drop off and again that's even spotty.

Gregg Gilbert - Merrill Lynch

Thank you very much.

Christopher B. Begley - Chairman and Chief Executive Officer

Thank you, Gregg.

Karen King - Vice President of Investor Relations

Operator, we have time for one more question.

Operator

Your final question comes from Taylor Harris. Your line is open.

Taylor Harris - J.P. Morgan

Thanks a lot. A couple of areas of your business where trends have been going against you recently are pricing in European specialty injectables and then sales to Abbott [ph] of course continues to decline and contract manufacturing. Can you just maybe comment on each of those, where is there a chance that things recover in those various business?

Terrence C. Kearney - Chief Operating Officer

Taylor, this is Terry, let me see if I can tackle it for you From a pricing respective and when you really look at that competitive landscape, as we told you since the beginning of the year, we did expect to see negative pricing especially in injectables outside of the U.S and clearly we're seeing there. But the good news there is it's not been as bad as we have expected and initially forecasted, that's the upside to it. Within the U.S., we are seeing a little competitive price pressures on the oncology portfolio on alternate side. So that's out there as well. So price is out there, it's... some of it was certainly expected.

We do think that over time, we will continue to see some year-over-year price degradation in the markets outside the U.S. again moving with the market, so it's not a surprise to us. And in the U.S. as we try to forecast into the remainder of the year, we'll price... some continuing price pressure on the alternate side, but we do expect that with the anniversary awards in our pharmacy contracts and the CPIU opportunities that we have will we will be able to mitigate some of the price decline anyway.

So we think price is we have a pretty good handle on it and it certainly was an area that it's actually doing little bit better than we would have forecasted in original. So that's not an issue against our projections.

Relative to contract manufacturing, again, to reduce volumes, but we do believe that there will be a slight rebound in the second half of the year. And most importantly, when you look at the strength in our other business, being the SIP business and MMS, we're able to make up those shortfalls. And you know anytime you put together 4-K there is some pluses and minus just to that and this year we're seeing some lower volumes in contract manufacturing, but we're able to offset that with strength in SIP and medication management primarily due to the growing momentum we have in the share gains we talked about. So, all in all that's why we are able to confirm the guidance that we provided today excluding the exchange impact of about 2%.

Taylor Harris - J.P. Morgan

Okay.

Christopher B. Begley - Chairman and Chief Executive Officer

This is Chris. Let me add something on the contract manufacturing piece longer term. If you think about that business and you had commented on the Abbott piece. The Abbott piece has been winding down ever since we spun, okay. And we have to and we have completed it, have an arms length negotiation with Abbott and we had to complete that by May of this year to look at what products they wanted us to continue to make.

That's all been done and so from a wind down standpoint, we'll experience that decrease through 2008. But then as we start rolling into 2009, we'll still see a little bit of year-over-year decrease, but then it will stabilize. And as we have always have talked about, the volume will be less but the margin trade-off will be just about equal in the incremental margin piece.

I think the other key piece on contract manufacturing is the person who leaves the organization and the team that he has reporting to have done a really good job of signing of new business contracts with pharma, biotech companies, et cetera. Now those are all for case three type of compounds that are not yet approved. And so like a pharmaceutical business, that business has some nice upside to if the drug ends up being approved by the FDA and then it ends up being double or triple or even a home run.

And so we experience some of the ups and downs that big pharma does in that businesses as well and I think the good piece as we look forward at it as we planted a lot of seeds by doing these contracts with pharma and biotech companies and hopefully will end up having some nice trees growing out of it that will end up growing very nicely. The other time, and I would make through all this is this year we have not lost any business in our contract manufacturing business whatsoever.

Taylor Harris - J.P. Morgan

Okay, great. Just last question, what... Terry you had touched on pricing in the U.S. SIP business. For that whole portfolio what that's running up this year?

Terrence C. Kearney - Chief Operating Officer

On the year-to-date basis on a competitive perspective in the U.S. I think it's slightly negative.

Taylor Harris - J.P. Morgan

Okay. And is that because I guess it's been in the 0% to 1% range for the previous couple of years. Is it simply a function of increased competition or is it the GPO contracts or what?

Terrence C. Kearney - Chief Operating Officer

Well, again from a comparative price perspective, it's really just again we're seeing more competition in the alternative side on the oncology portfolios is really what's driving from the competitive perspective.

Taylor Harris - J.P. Morgan

Okay.

Christopher B. Begley - Chairman and Chief Executive Officer

From a strategic standpoint as Terry talked about in his comments, we have some increased GPO awards from the breath standpoint on SIP specifically that you know will contribute to that as well.

Taylor Harris - J.P. Morgan

Got it. Okay, thank you.

Christopher B. Begley - Chairman and Chief Executive Officer

Thank you Taylor.

Karen King - Vice President of Investor Relations

Thanks. And that concludes our call for the quarter. Thank you for joining us today. Jessica, we are now ready to end the call.

Operator

This concludes Hospira's second quarter 2008 conference call. You may now disconnect.

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Source: Hospira, Inc. Q2 2008 Earnings Call Transcript
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