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Baxter International Inc. BAX
Q1 2010 Earnings Call Transcript

Transcript Call Date 04/22/2010

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

I would now like to turn the call over to Ms. Mary Kay Ladone, Corporate Vice President, Investor Relations of Baxter International.

Ms. Ladone, you may begin.

Mary Kay Ladone - Corporate VP of IR: Thanks, Sean. Good morning, everyone and welcome to our first quarter 2010 earnings conference call. Joining me today are, Bob Parkinson, CEO and Chairman of Baxter International, and Rob Davis, Chief Financial Officer.

Before we get started, let me remind you that this presentation including comments regarding our financial outlook, new product developments and regulatory matters contain forward-looking statements, that involve risks and uncertainties and of course our actual results could differ materially from our current expectations. Please refer to today’s press release and our SEC filings for more detail concerning factors that could cause actual results to differ materially.

In addition, in today’s call, non-GAAP financial measures will be used to help investors understand Baxter’s ongoing business performance. A reconciliation of the non-GAAP financial measures being discussed today to the comparable GAAP financial measures is included in our earnings release issued this morning and available on our website.

Now, I’d like to turn the call over to Bob Parkinson.

Robert L. Parkinson, Jr. - Chairman, CEO and President: Thanks, Mary Kay. Good morning, everybody. Thanks for calling in. Our Q1 results that we reported earlier this morning were very solid with adjusted EPS of $0.93 per share, an increase of 12% versus Q1 of 2009 which as you know was in line with our prior guidance. As you saw, our sales increased 11% for the quarter on a reported basis and on an organic basis sales increased 5% which was at the lower end of our guidance.

Sales in all of the major businesses and virtually all of the product categories achieved or exceeded expectation with the exception of plasma proteins in the U.S. So on that point, let me jump immediately to the obvious news this morning which is our decision to lower guidance for the year from $4.20 to $4.28 a share to $3.92 to $4 per share. While Rob will provide more details in just a few minutes, it’s clearly appropriate for me to address the basis of our decision to lower guidance at the outset this morning.

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

So we estimate the total healthcare reform impact for 2010 to be approximately $80 million, which is about $0.10 per share. The second factor is really, I guess what I would describe is the more protracted and pronounced impact of the transition in the global plasma protein market, particularly with emphasis in the U.S.

We’ll clearly discuss this in more detail in the Q&A this morning, but what I like to do is provide some color as it relates to the existing market dynamics, the basis of our projection for the remainder of the year but also our longer term view regarding this business.

In the short-term, it’s evident that the market is growing more slowly than our earlier estimates, particularly in the U.S. As I commented last quarter, we also believe that we’ve lost some unit share are primarily business that we gained in late ‘08 or early ‘09 due to some competitive supply issues.

As you know, we’ve not taken prices up this year on GAMMAGARD LIQUID, but it remains the premium brand and is frankly subject to some competitive vulnerability, particularly in select segments of the market. So as a result, we have and we will, on a targeted basis, selectively touch up prices.

While I continue to believe that we and the market more broadly are going through a transitionary period. We, in retrospect, we’re clearly overly optimistic about the short-term market growth. Our ability to retain market share in the near term impact on the market of deploying additional sales resources for indications there remain under diagnosed and untreated.

Despite our positive outlook on the growth of the business over the LRP for the reasons mentioned, we felt it was prudent to adjust down our projections for the remainder of 2010. We do remain confident, as I mentioned, that this business will be an attractive growth vehicle in the coming years due to new and proprietary administration technology such as our HYQ program which utilizes Halozyme’s enhanced technology, new indications such as MMN and of course the potential wildcard of an Alzheimer’s indication.

We also, as you know, continue to expand sales force and marketing resources around the world to broaden access to patients who have not been diagnosed with primary immune deficiency.

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

The other BioScience businesses in the first quarter performed well. Recombinants, regenerative medicine, which as you know is our BioSurgery business and vaccines, all generated double-digit sales growth. We’re also encouraged by the accelerating growth in the quarter of Medication Delivery and the solid growth of Renal, which I think very much exemplifies the balance of our diversified healthcare model.

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

So at this point, I would ask Rob to get into some of the specifics of the Q1 results, our revised guidance for the year and then I want to come back after that and provide a little broader context and some commentary on our earnings revision.

So with that, Rob, if you would?

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

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

Now let me briefly walk you through the P&L by line item before turning to our financial outlook for the remainder of 2010.

Starting with sales, worldwide sales totaled $3.14 billion in the first quarter and increased 11%. Sales growth, excluding foreign currency, was 5% and as Bob mentioned earlier was at the lower end of our guidance primarily due to lower than expected plasma protein and antibody therapy sales. Sales growth in the U.S. was 4%, international sales increased 17% on a reported basis and excluding foreign currency, sales growth was 5%.

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

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

Moving onto plasma proteins, which includes a broad array of products including Feiba, an inhibitor therapy; Aralast a treatment for hereditary emphysema; Flexbumin or Albumin provided in the flexible plastic container as well as plasma-derived factor VIII and traditional Albumin. In the first quarter, global plasma protein sales were $292 million, an increase by 7%. Excluding the impact of foreign currency, plasma protein sales declined 1% as lower Albumin and PD factor VIII sales more than offset double-digit growth of Feiba and Aralast.

In the U.S., plasma sales declined 4% as growth of Aralast, plasma-derived factor VIII and Feiba were more than offset by lower sales of Albumin where we faced a difficult comparison to last year when U.S. Albumin growth was approximately 40%. International sales, excluding foreign currency, were flat to last year as double-digit growth of Feiba offset lower sales of PD factor VIII and Albumin resulting from lost or delayed tenders.

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

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

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

Turning to the product categories, IV therapy sales totaled $391 million in the quarter and grew 14%. Excluding foreign currency, sales increased 6% and were driven by increased demand globally for IV solutions and nutritional products as well as improved pricing.

Global injectable sales advanced 22% to $451 million. Excluding foreign currency, sales grew 14%. In addition to an easy comparison to last year, growth was driven by increased pharma partnering sales, growth of select premixed drugs, and certain multi-source generics as well as double digit growth of our pharmacy compounding business outside of the United States.

Infusion systems sales totaled $209 million and increased 5%. Excluding foreign currency, sales declined 1%. Strong sales of the SIGMA Spectrum pumps were more than offset by lower COLLEAGUE and access set revenues. And finally, anesthesia sales totaled $127 million and increased 17%. Excluding foreign currency, sales increased 11% driven by growth of both SUPRANE and sevoflurane.

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

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

Turning to the rest of the P&L and starting with gross margin. Gross margin in the first quarter of 51.9% was 80 basis points lower than last year’s first quarter gross margin of 52.7%. All three of our businesses expanded margins in the quarter. However, this expansion was more than offset by three items.

First, the impact of healthcare reform, which as mentioned earlier, totaled approximately $15 million in the quarter. Second, approximately $20 million of write-offs related to H1N1 vaccine inventories. And third, the loss of foreign currency hedge gains that benefited last year’s margin by approximately 100 basis points.

Turning to SG&A. SG&A of $683 million in the quarter increased 12%. Excluding foreign currency, SG&A increased in mid single digits. R&D spending of $227 million increased 7% and excluding currency, R&D grew in the low single digits.

Our operating margin was 23% for this first quarter, which is 50 basis points lower than last year as a result of the specific items noted earlier, which negatively impacted gross margin.

Interest expense was $19 million compared to $26 million last year, which was principally a result of higher interest income and other was an expense of $2 million similar to last year as miscellaneous expenses more than offset foreign currency gains.

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

Turning to cash flow, the year started off quite strong. Cash flow from operations totaled $279 million, an improvement of more than $40 million compared to last year. Excluding pension contributions from both years, first quarter cash flow from operations approached $600 million, reflecting an improvement of more than $250 million year-over-year.

DSO ended the quarter at 53 days, which is slightly higher than last year. This increase is entirely due to our mix of receivables outside the U.S. as our DSO in the U.S. remains under 30 days. Inventory turns of 2.2 turns improved from 2.1 turns in the first quarter last year, reflecting flat or modestly improving turns across all three businesses.

Capital expenditures totaled approximately $230 million compared to $171 million last year as we continued to invest in appropriate capacity expansions across our businesses to support our growth.

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

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

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

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

In addition to this impact of healthcare reform, our revised guidance also reflects our current outlook for BioScience with the major driver being the adjustment of our plasma protein business.

But before I walk you through the sales guidance by business, let me take a moment to summarize our revised guidance by line item of the P&L.

First, we expect full year sales growth, excluding the impact of foreign currency, of 1% to 3%. The reduction in our sales is primarily the result of the two factors mentioned earlier, healthcare reform and lower sales of plasma proteins. Excluding these factors, our sales guidance would have been within our previous guidance range.

In addition, based on current foreign exchange rate outlooks, we expect our full year reported sales growth of 3% to 5%. Obviously, the foreign currency benefit on the sales will be greater in the first half of 2010 versus the second half of the year.

For the full year, we now expect gross profit as a percentage of sales to decline 100 to 150 basis points from the 2009 gross margin rate of 52.4%, primarily resulting from the specific items noted earlier and the ongoing impact of healthcare reform.

Given our sales and margin outlook, we will intensify our focus on managing cost throughout the company. Therefore, we now expect SG&A and R&D to be flat to 2009 levels.

We expect interest expense of approximately $100 million and other expense to total approximately $30 million to $40 million. We expect our tax rate to approximate 19.5%. And finally, we expect a full year average share count of 600 million shares.

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

Now, to expand on the sales assumptions for each of the three businesses. First, as Bob mentioned earlier, we are encouraged by the results in Renal and Medication Delivery and we continue to expect both businesses to perform in line with our original sales expectations of mid single digit growth.

For BioScience, we now expect sales growth excluding foreign currency to be flat to down 2%. By product category, our revised guidance reflects the impact of healthcare reform and additional sales of approximately $60 million related to the acquisition of ApaTech. For the recombinant business, we now expect recombinant sales growth in the 4% to 5% range.

Second, we expect plasma protein sales to decline in mid single digits and antibody therapy sales to decline in the 10% to 15% range.

Third, we expect the regenerative medicine business to have sales growth exceeding 25% reflecting the ApaTech acquisition and continued double digit growth in the base business.

And finally, we expect the other category to decline by approximately 5% due to a more conservative outlook of lower advanced purchase revenues now that the H1N1 pandemic has subsided.

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

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

Robert L. Parkinson, Jr. - Chairman, CEO and President: Thanks, Rob. First of all, let me say, clearly, we are disappointed to be in a position to lower our earnings guidance for the year. But as we discussed and as we will get into more detail in the Q&A, clearly the market realities of the plasma business they are what they are. We will talk about that, and we have to be realistic and we have to be objective as possible in providing new guidance for the year.

On the healthcare reform upfront, now that that can be calculated, frankly, we reflected in our base and we move on. So given the reduction in guidance, an obvious question that I am sure many of you are asking is, what is the impact of this revision on our five-year LRP that we presented as recently as last September’s Investor Conference.

First of all, I think you know, we didn’t include any impact of healthcare reform in the numbers that we presented this past September, neither the Medicaid rebate, drug and device tax nor on the other hand, any impact on demand due to broader coverage, which becomes effective later in the LRP.

So in addition, just to give you a little clarity on that, in addition to the $80 million impact that we’ve now reflected for 2010, there will be some incremental impact in 2011 for the pharma tax and, of course, the device tax, as you know, kicks in, in 2013.

Having said that, I would tell you the $80 million impact that we’ve reflected for this year represents the lion’s share of the cumulative impact over the five-year LRP. So on that front, effectively, that impact would need to be overlaid in our numbers that we presented to you last September.

Our revised outlook for the plasma protein business would also need to be adjusted in the LRP. Now, while as we said and you know this business is going to grow nicely for us over the long-term, the short-term base which is really this year and into 2011 will need to be now adjusted in our five-year projections.

So, the real question is, how long will it take to rebase for us to feel the effect of various commercial strategies that we’ve implemented and will implement going forward and, then of course, get back to a position where we’re accelerating growth. That’s a question, frankly, I can’t answer at this point, but we hope to be in a better position to provide more definition on that as the year progresses.

Before we open it up to Q&A and in closing, I would just tell you that we remain committed to grow our earnings over the long-term in line with the rates that we did discuss with you last September. To the degree whether it’s the macro business environment is more challenging or the current plasma protein dynamics are more protracted than we’ve estimated, we’ll certainly take actions to ensure that we create sustained growth and value creation for our shareholders whether that means a different pathway for business development or M&A, a reassessment of our structural costs of our company, or whatever other responsible measures are necessary for us to achieve our objectives. I want to be clear on that before we open it up to Q&A.

So, at this point, Mary Kay, why don’t we do that?

Mary Kay Ladone - Corporate VP of IR: Sure. Thank you. Sean, can we open it up for Q&A please?

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