Baxter International Inc. (BAX) Q2 2011 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen, and welcome to Baxter International's second quarter earnings conference call. [Operator Instructions] As a reminder, this call is being recorded by Baxter and is copyrighted material. It cannot be recorded 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.

Thanks, Sean. Good morning, everyone, and welcome to our Q2 2011 earnings conference call. Joining me today are Bob Parkinson, CEO and Chairman of Baxter International; and Bob Hombach, Chief Financial Officer. Before we get started, let me remind you that this presentation, including comments regarding our financial outlook, new product 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 details concerning factors that could cause actual results to differ materially. In addition, in today's call, non-GAAP financial measures will be used to help investors understand Baxter's ongoing business performance. A reconciliation of the non-GAAP financial measures being discussed today to the comparable GAAP financial measures is included in our earnings release issued this morning and available on our website. Now I'd like to turn the call over to Bob Parkinson.

Thanks, Mary Kay. Good morning. Thanks for calling in. We're pleased this morning to announce financial results for the second quarter and also provide you with an update on our full year 2011 outlook. As you all saw in the press release that was issued earlier this morning, adjusted EPS of $1.07 per diluted share exceeded guidance for the quarter and increased 15% versus the prior year. This performance was a result of double-digit sales growth, operational leverage, foreign currency favorability and the benefit from our ongoing share repurchase program. Second quarter sales growth, after adjusting for FX, was 6% as growth improved on a sequential basis across multiple categories in BioScience. Year-to-date sales growth, again after adjusting for FX and the revenue adjustment in 2010, was 5% and EPS accelerated 10%. While Bob will provide more details on Baxter's financial results for the first half of the year in just a few minutes, as indicated in the press release issued this morning, we have raised our full year sales guidance on a reported basis as well as our full year earnings guidance before special items. While we're pleased with the improving fundamentals and enhanced financial performance as evidenced by our first half results, I highlight that we continue to navigate through a challenging macro environment that's evolving on a global basis and continues to exert ongoing pressures on our business and the healthcare industry more broadly. Having said that, we're particularly vigilant in monitoring the external environment and remaining focused on accelerating future growth by leveraging the broad and diverse nature of our product portfolio, our geographic reach and capitalizing on the unique opportunities for expansion that our new product pipeline affords. In fact, during the quarter, we did achieve a number of milestones that reflect enhancements to our commercial, operational and scientific effectiveness, and I'll mention just a few. For example, the SIGMA Spectrum Infusion pump received the "Best in KLAS" award for smart pumps in the 2011 Top 20 Best in KLAS Awards for Medical Equipment & Infrastructure report. This award represents the aggregate opinions of healthcare executives, purchasing managers and clinicians for more than 4,500 hospitals and reflects the high level of customer satisfaction with the Spectrum pump, which scored the highest in overall performance, reliability and delivery of technology. We also completed the acquisition of Prism Pharmaceuticals and launched NEXTERONE, the first and only ready-to-use premixed formulation of the antiarrhythmic agent, amiodarone. Given this drug is typically administered to patients in extremely time-sensitive situations, the benefits of a ready-to-use premixed form allows for immediate use and reduces the potential risk of medication errors. We believe this unique product satisfies unmet clinical needs, offers an opportunity to expand the current market and has the potential for application in additional geographies outside the United States. We're pleased that data from Baxter's Phase II CMI adult stem cell program was recently published in Circulation Research. Results demonstrate that injection of the patient's own CD34+ adult stem cells into targeted sites in the heart have therapeutic benefits such as reduced angina episodes and improved exercise tolerance. More than 850,000 individuals in the U.S. experienced refractory angina associated with CMI and have not responded to other therapeutic options. We look forward to moving into Phase III clinical trial later this year. We also continue to be successful in driving differentiation of GAMMAGARD LIQUID by offering various dosage presentations, enhancing delivery options and expanding the number of indications. For example, earlier in the quarter, we introduced the first and only 30-gram dose vial for GAMMAGARD LIQUID in the U.S. This new dosage form is the most frequently prescribed dose for primary immune deficiency patients and enhances user convenience, and we're pleased with the rapid pace of customer adoption since the launch. I've mentioned that FDA approval for GAMMAGARD LIQUID 10% Sub-Q is imminent. We plan to launch Sub-Q in the U.S. during the third quarter and participate in this fast-growing segment of the market. We recently submitted the Biologics License Application to the FDA for approval of HyQ, allowing for the enhanced subcutaneous administration of immunoglobulin, with recombinant human hyaluronidase for patients with PID. The submission is based on results from a Phase III trial, which met both its primary and secondary endpoints. We're currently in the process of preparing our submission for approval in Europe and Canada and expect to communicate final results later in the year. As you all know, Baxter is conducting Phase III clinical trials exploring the use of GAMMAGARD LIQUID as a therapy for 2 neurological conditions. The first is a trial for the treatment of multifocal motor neuropathy or MMN. We continue to be on track to complete the trial in the U.S. and Canada later this year and submit for approval in 2012. Additionally, during the second quarter, we received a positive opinion by the European Medicines Agency to include MMN as a new approved indication in all European member states. This represents the first and only centrally licensed indication for MMN in Europe. And finally, we continue to advance our Phase III trial for Alzheimer's, as we've now completed enrollment in our first Phase III trial with more than 360 patients. With an 18-month follow-up period, we currently expect to complete the trial by the end of 2012. In addition, we plan to initiate a second confirmatory trial before the end of this year. As we've previously stated, accelerating innovation is the cornerstone of our future success. Given this important strategic imperative, we expect R&D spending to ramp in the second half of this year as we further advance our pipeline with continued development of hemophilia therapies, including our longer-acting Factor VIII therapy and recombinant von Willebrand programs and initiate several clinical trials such as the second Phase III trial for Alzheimer's, a Phase III adult stem cell trial for patients with CMI and also begin the first trial evaluating our home hemodialysis device. As always, I'd be happy to address any questions on these programs and others during the Q&A, but we look forward to updating you on the achievement of additional R&D milestones throughout the remainder of the year. So with that, I'd now like to ask Bob to review our second quarter financial results and also our guidance for 2011. Bob?

Thanks, Bob, and good morning, everyone. Let me briefly walk you through the P&L by line item for the quarter before turning to our revised financial outlook for 2011. Starting with sales, worldwide sales totaled $3.5 billion in the second quarter and advanced 11%. Excluding foreign currency, sales grew 6%, which compares favorably to the guidance we've provided of 4% to 5%. This is primarily the result of robust growth in plasma proteins and antibody therapies, as well as better-than-expected vaccine revenues and the benefit of unplanned sales of approximately $20 million related to the U.S. multisource generic injectables business divested in early May. In terms of individual business performance, beginning with BioScience. Global BioScience sales of $1.6 billion increased 14% in the second quarter. Excluding foreign currency, BioScience sales increased 10%, reflecting a sequential improvement in the growth rate of 6 percentage points versus growth in the first quarter of this year. Within the product categories, recombinant sales of $570 million grew 9%. Excluding foreign currency, sales improved sequentially on a global basis and increased 3% driven by improved growth outside the U.S. Excluding the impact of the U.K. tender, which has now been substantially annualized, recombinant growth was in mid-single digits globally and international growth was in high single digits. Moving on to Plasma Proteins. Sales in the quarter were $363 million and increased 16%. Excluding the impact of foreign currency, sales rose 11% due to strong demand, particularly outside the U.S., for FEIBA, albumin and plasma-derived Factor VIII. More than 70% of our plasma revenues are outside the U.S. where growth on a constant currency basis was 20% and offset lower sales in the U.S. The 6% decline in the U.S. was driven by a short-term backorder situation for ARALAST and the impact of higher rebates on FEIBA due to a significant increase in patients reimbursed by Medicaid. In antibody therapy, sales of $381 million increased 23%. Excluding foreign currency, sales climbed 21% driven by robust demand. This performance continues to reflect the success we've had with our commercial strategies and the benefit related to meeting volume previously served by Octapharma, which for the quarter was an incremental $30 million to $40 million in sales. Sales in regenerative medicine, which includes our BioSurgery products, totaled $147 million and increased 11%. Excluding foreign currency, sales increased 6%, driven by double-digit growth of surgical sealants and hemostats. This growth was partially offset by lower Actifuse revenues, triggered by a temporary disruption in the channel resulting from a recent integration-related decision to transition from the ApaTech distributor model to primarily a direct sales model, which is consistent with our current go-to-market strategy within the BioSurgery business. Finally, revenues in the other category, which includes vaccines, totaled $92 million increasing 21% versus the prior year. Excluding foreign currency, sales increased 12% due to strong growth of FSME vaccine in Europe. In Medical Products, global sales in the second quarter totaled $2 billion, reflecting an increase of 8% on a reported basis. After adjusting for foreign currency, sales increased 3%, and after also adjusting for U.S. multisource generic injectable divestiture, sales growth was 5%. Turning to the product categories. Renal sales totaled $633 million and increased 8% on a reported basis. Excluding foreign currency, sales growth improved sequentially as PD growth globally accelerates the 5% due to continued momentum in patient gains in the U.S., Latin America and Asia. This performance was offset by expected loss of PD patients to another U.S. service provider and lower HD revenues. Sales in the Global Injectables category advanced 7% to $506 million, and excluding foreign currency, sales grew 3%. Excluding the divestiture, growth of this category was 10%. Contributing to this performance was a very strong growth in our Contract Manufacturing and Compounding businesses as well as strong demand for MINI-BAGs. IV Therapy sales totaled $452 million and rose 8%. Excluding foreign currency, sales were up 3%, driven by low single-digit growth of IV solutions and double-digit growth in the U.S. Nutrition business as a result of continued share gains related to competitor supply shortages. Infusion System sales totaled $233 million, reflecting growth of 8% and sales were up 5%, excluding foreign currency. Growth was driven by expanded placements in sales of the Spectrum pump, which reached a new high in the quarter. Finally, anesthesia sales of $143 million increased 10%, and excluding foreign currency, sales grew 8%. This performance was driven by improved demand, which was somewhat offset by competitive pricing pressures for generic Sevoflurane. Turning to the rest of the P&L. Gross margin for the company was 51.9% in the second quarter, which exceeded expectations and reflects a sequential improvement of 90 basis points versus the first quarter. Compared to the prior year, gross margin improved by 60 basis points as a result of mix improvements, primarily driven by strong sales of high-margin vaccine and anesthesia products and a modest benefit from foreign exchange. These items more than offset incremental costs associated with the Castlebar PD solution issue and the impact of manufacturing inefficiencies incurred in the Plasma business during 2010. SG&A totaled $765 million in the quarter and increased 10% versus the prior year period, with the impact of foreign currency driving nearly half of the year-over-year growth. We continue to aggressively manage general, administrative and discretionary spending areas across the company, while making select investments in a number of key promotional areas aimed at demand creation and new product launches. In addition, we continue to recognize the incremental savings associated with the actions we announced in January, which were offset by incremental pension expense and the pharmaceutical drug tax. R&D spending accelerated in the second quarter to $239 million, representing an increase of 9% in the quarter as we continue to advance our pipeline and fund many of the exciting programs we've discussed with you over the last several years. The operating margin in the quarter was 23.5%, reflecting an 80 basis point improvement both sequentially and over the prior year period. Interest expense was $15 million compared to $25 million last year. This reduction is primarily the result of a benefit from higher rate debt and maturity in the second half of 2010 and higher interest income. Other totaled $13 million this quarter compared to $3 million last year, with the increase driven primarily by the impact of foreign exchange on balance sheet positions and noncontrolling interest. The tax rate was 21.7% in the quarter, 180 basis points higher than last year's rate of 19.9% and is the continued result of a change in earnings mix between higher tax and lower tax jurisdictions. And finally, as previously mentioned, adjusted EPS increased 15% to $1.07 per diluted share, which exceeded our guidance of $1.01 to $1.03 per share. Turning to cash flow. Cash flow from operations in the quarter totaled $632 million compared to $783 million in the prior year period. The reduction year-over-year is the result of an increased outflow related to working capital and $87 million in payments for the infusion pump recall and business optimization actions we announced earlier this year. The working capital outflow is driven by higher receivables, particularly in Europe, and increased inventory levels to meet anticipated demand for infusion pumps and PD solutions given the Castlebar situation. In addition, over the last 6 months, we have ramped internal plasma collections and purchased significant quantities of third-party plasma. DSO ended the quarter at 58 days, which is higher than last year by 4 days. This is largely due to the challenging macro environment and our international country mix as DSO in the U.S. remains at approximately 30 days. Inventory turns of 2.5 are comparable to the prior year. This is primarily driven by improvement in BioScience versus the second quarter of 2010, offset by low returns in Medical Products. Capital expenditures in the quarter were $210 million versus $237 million in the prior year period and are also trending below 2010 on a year-to-date basis. And lastly, during the second quarter, we repurchased approximately 8 million shares of common stock for $478 million. Through the first 6 months of the year, we have repurchased 21 million shares for $1.1 billion, or on a net basis, 14 million shares for approximately $824 million in line with our full year objective. Finally, let me conclude my comments this morning by providing our financial outlook for the third quarter and full year 2011. First, for the full year, we now expect earnings of $4.27 to $4.32 per diluted share. By line item of the P&L and starting with sales, we expect full year sales growth, excluding foreign currency, of 3% to 4%. We currently expect foreign currency to benefit sales growth by approximately 2 points. Therefore, we expect reported sales growth of approximately 5% to 6%. This outlook includes the first half sales of approximately $60 million related to the U.S. multisource Generic Injectables business and $60 million to $70 million of incremental sales related to Octapharma. The impact of these nonrecurring items depresses our second half sales growth by approximately 2 points. For the full year, we continue to expect gross margin in the 51% to 51.5% range with a modest improvement over the gross margin rate in 2010 of 51.1%. We now expect both SG&A and R&D to grow in mid-single digits for the year. The projected increase in the growth rate is primarily due to foreign currency impacts and a ramp in R&D spend in the second half relative to our original guidance. We expect operating margin to improve modestly year-over-year. We now expect interest expense of approximately $60 million to $70 million and other expense, which includes noncontrolling interest, to also total approximately $60 million to $70 million. Given our mix of earnings, we expect our tax rate to approach 21.5%, and finally, we expect a full year average share count of approximately 575 million shares, which assumes approximately $1 billion in net share repurchases. From a cash flow perspective, we continue to expect cash flow from operations of approximately $2.8 billion. This includes a 2011 pension contribution of $150 million and an outflow of approximately $300 million related to the execution of a COLLEAGUE consent order. Now to expand on full year sales assumptions for each of the businesses. First, on a constant currency basis, we expect low single-digit sales growth for medical products. Excluding the impact of the generic injectables divestiture, sales growth is expected to be mid-single digits. Within the product categories, there is no material change from our previous guidance. We continue to expect renal sales to grow in low single digits, anesthesia sales to grow in low to mid-single digits, Infusion System sales to be approximately flat and IV Therapy sales to grow in mid-single digits. In addition, we expect global injectable sales to increase in low single digits. Excluding the generics divestiture, we expect sales in this category to increase 10% to 12%. For BioScience, we now expect sales, excluding foreign currency, to grow in the 5% to 6% range, which is at the higher end of our prior guidance. For the Recombinant business, we now expect sales growth for the full year to be in low single digits. Second, we expect plasma proteins sales to increase in high single digits and Antibody Therapy sales to increase approximately 10%. Our current guidance assumes a modest benefit in the third quarter related to Octapharma as we currently assume that they will return to the U.S. market by the fourth quarter. As a reminder, due to year-over-year sales comparisons related to Octapharma, we expect Antibody Therapy sales growth to moderate in the back half of 2011. Third, we expect regenerative medicine sales to grow in the low to mid teens, and finally, we expect the other category within BioScience to decline approximately 10%, reflecting the better-than-expected sales in the second quarter and the difficult comparison from pandemic revenues generated in the first quarter of 2010. For the third quarter, as we mentioned in our press release, we expect earnings per diluted share of $1.07 to $1.09 and sales growth, excluding the impact of foreign currency, of 3% to 4%. Based on our outlook for foreign exchange rates, we expect reported sales to increase in the 6% to 7% range, reflecting a 3 percentage point benefit from currency. Thanks, and now I'll open up the call for Q&A.

[Operator Instructions] I would like to remind participants that this call is being recorded and a digital replay will be available on the Baxter International website for 30 days at www.baxter.com. Our first question comes from David Roman with Goldman Sachs.

I wanted to come back first to the financial guidance, then, Bob Parkinson, ask you a product-related question. As you go through kind of the numbers for the second quarter and the first half of the year then look to the back half of the year, particularly on the gross margin, it looks as though for the balance of the year you're sort of saying that things will be consistent with where they were in the first half. Could you maybe walk us through some of the items that positively affected gross margin in the quarter that you're thinking may not recur in the second half? It sounds like business trends by and large are improving from a top line perspective and why we wouldn't then see that flow through to the P&L?

Sure, David. So a couple things. We mentioned one of the areas of outperformance in the second quarter was the vaccine business. That is a high-margin business for us. The FSME product, in particular, is primarily a seasonal vaccine. So the second quarter is by far the peak. In the back half of the year, the contribution of FSME to our top line is much, much smaller than it is in the second quarter, so the positive benefit we saw in the margin in the second quarter won't repeat there. Recall that anesthesia underperformed in Q1 related to finalization of a distributor agreement in the U.S., which we did execute in the second quarter. We saw some catch up there again on some higher margin product, and so that was a bit exaggerated in the second quarter. And then FX, we did get a slight benefit to margin related to foreign exchange in the second quarter as the dollar weakened against the euro and many other currencies, particularly emerging and developing markets. In the back half of the year, given recent events that are going on with the U.S. debt crisis and the situation in Europe, we've seen the dollar strengthen a bit. So we're not assuming that modest FX benefit. It's a margin in the back half of the year. Other than that, though, the underlying dynamics of our higher margin products growing faster and the mix benefits we see persisting. And adjusting for some of the items I've mentioned, we do see some improvement operationally in margin in the back half versus the front half in the neighborhood of 40 to 50 basis points, somewhat masked, again, by the dynamics that I mentioned.

Okay, and then if you look at growth outside the United States this quarter, you highlighted that in your prepared remarks, almost every single business showed a sequential improvement in year-over-year growth rates. Can you maybe help us understand where that's coming from especially when you square that up against some of the challenging dynamics that are happening in Europe and what we hear about pricing trends in Europe across for many of your pharmaceutical peers?

Yes, I would -- this is Bob Parkinson, David. A number of pieces to that. The reality is the European markets continue to be challenging, particularly the more developed Western markets. But having said that, we continue to benefit significantly by emerging developing markets, China, Brazil and so on. Also, generally speaking, the plasma proteins across the board, including developed Europe, were very strong in the second quarter. So it's tough to generalize regarding all markets outside the U.S. We are pleased by the overall strength and growth of our sales outside the U.S., but it is really -- the dynamics are very different between developed Europe, which continues, and we anticipate it's going to continue to be challenging versus our expanding investment and presence in emerging and developing markets, which consistently has been a growth priority for us.

And then lastly, could you just update us on where you are with respect to IVIG supply? I think on the last call and on the fourth quarter call, you talked a little bit about supply constraint, and at one point, I think you were on pretty significant back order in the first quarter. Can you maybe sort of give us some sense as to where we stand on that?

Our position today is much better than what it was I think at the time of the last call. But having said that, we're really not flush with inventory right now as a result of the Octapharma situation. And again, my comment a second ago, particularly in growth outside the U.S., meeting demand, we're doing everything we can to do that. So while our situation, David, has improved dramatically, it's still not flush. And we're continuing to monitor that very closely throughout the rest of the year, particularly in view of some of the anticipated approval stand that we're going to get. So we continue to put everything behind making sure we have adequate supply.

David, let me also add, just as we mentioned last quarter that as long as Octapharma is out, there could be periods where there'd be temporary shortages or we'd be in a backorder situation for throughout the rest of this year.

Mike Weinstein of JP Morgan.

I wanted to maybe just dive in a bit more to your thoughts on the back half of the year. You're coming off of a strong quarter. It did sound like there were some one-time items that might have helped out a little bit, but still underlying a very strong quarter. But you didn't change your constant currency revenue growth outlook for the year, which is 3% to 4%, and you are assuming some slowdown in the back half. I think it would be helpful to get a sense of where you think you might be conservative in that forecast as part of it that you're assuming that Octapharma does make some inroads back into the market and that's why you're being a bit conservative. Are there other parts of your business where you are being conservative? Or am I just pushing it and 3% to 4% is the right type growth level to be thinking about right now?

Let me just -- I'll turn this over to Bob, because there's a lot of moving pieces. You're right, the Octapharma piece that you mentioned, Mike, is in fact part of it, but it's just one of a number of pieces, so I'm going to let Bob kind of walk you through.

Yes. Starting out first with -- on the constant currency guidance, recall that some multi-sourced generic business is out, and so that is driving about 1.5 points in the back half of drag on our growth rate as we work through trying to annualize that out over the next 4 quarters. So I think that's a key one. We are assuming, while Octa is back in Europe at the moment, and we are assuming that they'd come back in the U.S. in the fourth quarter as well. So that takes another 0.5 point or so out of the growth rate. So I think adjusting for just those 2 items, you're kind of back in the 5%-ish range, and I think that's consistent with...

With FSME as well.

Yes, and FSME, given the seasonality that we talked about earlier. So the way -- as we adjust for some of these impacts and look at the growth rate, it's pretty consistent through the quarters.

Mike, just to put it into perspective, first half growth constant currency was 5%. Second half, we're guiding to about 2% to 3% to get to our full year of 3% to 4%, and as Bob mentioned, that's 2 points of the generic injectable business and the assumption that Octapharma is back. And we're pretty conservative with our assumptions there that we cede that share back to them. And also I'd point out that in the back half of last year, plasma proteins was particularly strong. You might recall first half last year, plasma was down about 8%, and in the second half of the year, it was up in call it the 7% to 8% range. So we have a difficult comp in the Plasma Protein business as well.

Understood, that's very helpful. Let me follow up on just a couple pipeline items, if I can. The first would be, and if you talked about it, I apologize; I missed it. The home hemodialysis program, is there an update there?

Yes, we will start our clinicals, I'll just say in the coming weeks, so very soon.

Okay, and no change to the timelines there.

No.

And the other pipeline would be the recombinant von Willebrand factor. Have you started the clinicals there?

We have not started yet, Mike, but we plan on starting the Phase III in the second half of the year, on track with our original expectations there.

Okay, and then last question, Bob, I just want to make sure we're on the same page on your thoughts on acquisitions and capital allocation. Is it still the likelihood that any deals we see at Baxter are going to be smaller deals, similar in size to ApaTech?

Yes, there's no change on that front than what we've messaged. There's a number of active PD deals that we're currently looking at, but these are the kinds of things that are consistent with what we've kind of messaged, so the kind of things you would expect. So I would tell you we would expect, certainly we hope that we'll do a couple things in the second half of the year.

Bob Hopkins of Bank of America is on the line with a question.

So first a question on Sub-Q, which you said was imminent in terms of a launch here. How much are you assuming for Sub-Q in your back half guidance? Is that a major contributor? And maybe just help us frame the opportunity and launch strategy. And then finally, one specific point on Sub-Q. We've heard from some doctors that your Sub-Q product has a lower injection site adverse event rate than the competition as per your clinical trials. So I was wondering if you could talk a little bit about that as well and the degree to which you think that might help the launch.

Bob, why don't you take the first part of the question? And Mary Kay, the second?

Sure. So given that we're very excited about the Sub-Q launch, we think that, again, it's going to allow us to participate in a fast-growing segment of the market. But as we indicated, given our current inventory situation, we'll balance how we penetrate that market with serving existing customers here in the back half as we work to get our inventory situation back up to more normal levels. So it's a very nice opportunity for us and will be a growth driver going forward, but I wouldn't say that it's a significant contributor in our assumptions at the moment to the back half.

And on the infusion site infection rate, Bob, we do have a lower rate. I think as you saw the data in our posters that have been presented, we're at about 2.5%, which is significantly lower to other Sub-Qs on the market that are in the 60% range. We believe that, that's really due to the purity and the tolerability of our product. And obviously, we do believe that, that could be a potential competitive advantage to our product versus the competition.

Okay, that's helpful. And then I just wondered if we could go through some of those puts and takes on the top line this particular quarter that you were talking about earlier, and I'll rattle off what I heard. Obviously, Octa, $30 million to $40 million. You talked about, I think, a $20 million benefit in unplanned sales from business to be divested in the regenerative line, some channel disruption, I was wondering if you could quantify that. And U.S. Plasma Proteins and ARALAST, you talked about a temporary negative, I believe. Could you quantify that? And then any other of the sort of smaller puts and takes in the quarter that you ran through?

Why don't you expand on that, Bob?

Yes, sure. So I mean, consistent with the Octa amount we've been talking about, the generics injectable, I said, we divested in early May, so we didn't have the month of April in the numbers, we didn't expect. The channel disruption in ApaTech for the quarter is less than $10 million, so a smaller base in the BioSurgery regenerative medicine line, so it does affect the growth rate, but not a huge number overall. And ARALAST, similarly, less than $10 million of an impact in the quarter due to the back order situation.

And just one other comp I'd also mention is the U.K. tender. Although we basically annualize that, we did have a small impact in the quarter. I'd put it in the $5 million range. And WinRho also affected us in Antibody Therapies slightly, but not material.

Okay, so those are the major puts and takes in terms of one-time items in the quarter.

Yes.

Kristen Stewart of Deutsche Bank is on the line with a question.

Just to make sure the sales guidance that you had provided by product line, that was all on a constant currency basis, the growth rates.

Correct.

Okay, and then can you just walk through maybe the interest expense and other change? Because both of those change relative to your last updates. Is that just kind of foreign exchange on the other expense line item? I know that bounces around a bit.

Foreign exchange does bounce around a little bit, but also the noncontrolling interest in the sundry line as well. As we look at that primarily relates to the SIGMA relationship, and as they've ramped up production on their end, we own 40% and consolidate them in our results up above and have to adjust for their 60% ownership through the sundry line. So as actively is ramped up, that becomes a bigger number on the expense side for us in sundry. On the interest front, we took a strategy in the middle of last year to move to slightly more floating rate debt than fixed through interest rate swaps. So we're benefiting from that, and that's driving some of the interest income. But also in the first half of this year, we have collected some late interest on outstanding receivables in Spain. These are hard to predict because there's a whole legal process you have to go through. So it tends to be lumpy, and we did collect $5 million to $10 million in the front half of the year related to that, which we're not necessarily counting on in the back half of the year to repeat.

And then just on SIGMA, can you just maybe help us get an appreciation for just how far through you think you've locked in some of the pumps that are still outstanding? And just kind of how much is outstanding in the field for COLLEAGUE?

Mary Kay, you want to -- or Bob?

Sure, I'll jump in and, Mary Kay, you can. So at this point, we're fairly far along with the discussions with our customer base, approaching 3/4 of the customer base has indicated a firm interest in either staying with us or moving to a competitor and we continue to be in a position of the majority of those staying with us. So we're pleased with the progress there. SIGMA continues to do very well on the production side, providing the adequate level of pumps for us to be very competitive in offering the free pump to replace the existing COLLEAGUE. So getting pretty far down the track and pretty consistent with the outcomes that we had expected both within our reserve and what we've been indicating up to this point.

You had an option to acquire the company. Does that expire at any particular point in time?

I believe it's middle of 2012.

Any thoughts there on intent?

That's something we continue to evaluate, and we've got a bit more time here. Again, we're very pleased with the performance of the pump. We've mentioned earlier the award that it was given and recognized as one of the best pumps on the marketplace, and we'll continue to evaluate the next step going forward.

Last and a quick one. You had mentioned updating the long-range plan potentially this year. Are you guys still planning on hosting a conference call? Or is that something to expect next year?

Yes, Kristen, this is Bob Parkinson. We haven't really decided yet. I think this question came up on last quarter's call. We realize the curiosity on your collective behalf and so on, but as I commented previously, and then actually in my formal comments this morning, I mean the external environment continues to be challenging. Number of things are settling out. And I think until we get a little more visibility on that, we're not going to be forthcoming. But we do plan on setting something up before long, so we'll let you all know.

Larry Keusch is on the line with a question of Morgan Keegan.

First on margins, I'm wondering, Bob, if you can quantify what Castlebar, the impact of Castlebar was in the gross margin. And then as I think about the second half of the year in your gross margin specifically, it would seem to me that your Plasma Protein business obviously is an extremely high fixed cost business. And as you start to ramp that up, increasing collection as you indicated, I suspect your fractionation capacity is running pretty full at this point given your attempts to increase your inventory. And then you mentioned that you've purchased plasma as well as frozen plasma at, I assume, attractive prices. So at some point, I would think that, that has to start to come through the margin. So I'm wondering if you could just talk a little bit about those 2 things.

Sure. So Castlebar in the quarter was $15 million impact, negative impact to margin in the second quarter after $25 million in the first quarter. So we are working it down a bit. We do expect another $10 million to $15 million of impact in the third quarter and hope to be running a normal operation by the fourth quarter, still yet to be fully resolved in Europe, but that's our assumption at this point. As it relates to plasma, we have been running very well in ramping up both collections and production to meet not only the Octa demand that became available, but also strong underlying dynamics both in the U.S. and outside the U.S. In terms of dynamics going forward, you mentioned the purchase of third-party plasma. So we purchased both plasma collected by third parties and plasma directly from, frozen plasma directly from Octapharma. But as you might imagine, our internal cost to collect is actually below what a third-party would do because we feel like we are the most efficient collector in the industry, given the BioLife network that we've set up over the years. And so we actually are incurring a slight negative related to running that plasma through our operation. We really just purchased the first bolus here in the second quarter. There'll be additional purchases both third-party and from Octa in the third and fourth quarter of this year. So actually over the next 6 to 9 months, we'll be working that through our manufacturing network and putting that product into the marketplace, and again, that will be a slight negative impact as we work that product through. But given the demand and the inventory situation, we felt it was the right thing to do for us to put us in the best position to service customers going forward.

The other thing that I would add to Bob's comments, Larry, your observation's right. As we utilize existing capacity, we do get favorable absorption on both collection and fractionation. But as you know, and I commented the last quarter, our current plans are now to leave old L.A. [ph] frac in operation for an extended period of time to meet the demand. But in order to do that, there will be some costs going forward associated with that, that were not earlier planned either. So that, in addition to the comments that Bob just made, it would be an offset to the improved efficiencies in terms of capacity utilization.

Got you. So when you sort of net out the positive variances that you had in the 2Q and you think about the increased volume coming through on IVIG and other plasma proteins in the second half, how should we be thinking about just the progression of gross margin?

Well, as I mentioned earlier, operationally, we do see some improvement in the 40 to 50 basis point range in the second half versus the first half. But the benefit we saw from the mix related to vaccines and anesthesia in the second quarter and to FX, we're not counting on those 3 in the back half, so those tend to offset the underlying operational benefit that we're talking about here, and that's why we didn't change the margin guidance for the back half.

Got you. And then just lastly, just any thoughts on what you think the U.S. and OUS market growth is currently for IVIG? How you're looking at that? And with Octa now out in Europe, what sort of observations are you seeing relative to how they're behaving out there?

Our outlook in terms of market growth really isn't any different than what we've communicated kind of mid-single digits in the U.S. and higher single digits OUS. Larry, so our view in that regard hasn't changed. Relative to Octa's reentry, it's speculative, and so I'm not going to speculate on that.

Rajeev Jashnani is on the line with a question of UBS.

Just following up on the last question. I was wondering if you could perhaps just reconcile the additional purchases of plasma with Octapharma as well as some of the third parties with respect to their return trajectory. That would seem to imply it's somewhat measured, but I was wondering if you could provide some perspective on that.

Yes, I mean, I'd hate to speculate, but I think the facts are that clearly, more product, more raw plasmas become available in the market over the last 9 months basically. But what we don't know is what they'd continue to collect themselves and how much they'd process. So again, I would simply be speculating. At this point, what we really were focused on is ramping up the both the collections and potentially accessing this third-party plasma in order to ensure that we had product available to meet what has turned out to be very significant demand for our product in the 20% range here in the last couple of quarters. And so that's really the approach we've taken and anything else, I'd say, would be speculation.

And if I could just follow up and perhaps you could also share some perspective on how you've thought about the accounts that you've selected and perhaps the patients that you've selected with the Antibody Therapy given some tightness in the market and just how you thought about that in terms of patients that -- or excuse me accounts that may be somewhat stickier than others?

Yes, we certainly focused a bit more on the U.S. versus Europe in terms of the Octa demand gap that occurred when they went out of the marketplace, and given the touch up pricing exercise we went through last year with the U.S. customer base, we feel very good about the position we're in, with the customers we have and we're very focused on continuing to grow those relationships. I think as we go forward here with the Sub-Q launch and HyQ, and hopefully in 2012, we'll have further opportunity to be even more selective. But from a -- we certainly have focused on trying to avoid particularly price-sensitive accounts in the U.S. and outside the U.S. as we've looked to fulfill some of the demand needs in the marketplace.

Mike Matson is on the line with a question from Mizuho Securities.

Just wondering on the NEXTERONE product that you acquired, can you maybe comment on to what degree that contributed to revenue in the quarter? And then just I guess the more important part of the question would be how big is that market opportunity currently?

Yes, I mean the contribution was -- we just launched the product. There was virtually no contribution to the results in Q2. Now our outlook for that product, the initial reception is very good, and I don't know if we've quantified when we did the deal, Mary Kay, what we think in the long-term projections. It's material.

Yes. I mean given the fact that it's a premixed form, we are out with a price premium on the product, which will help expand with the current market potential, as well as we're looking at additional geographies to launch in. We pegged the market opportunity at about $150 million to $200 million globally.

Okay, that's helpful. And then you obviously had strong gross margins this quarter. It looks like you are getting back relatively close to kind of the recent peak of around 53% that you saw in 2009. Is there any reason that you couldn't in the long, long run, go well beyond sort of that low 50s range, maybe in the mid 50s range or even the high 50s?

Well, look, I think the big driver long-term, Mike, is the timely and successful launch of our pipeline now as it comes to fruition. Because obviously, and I'm generalizing now, but most of the new products that we've invested in will generate higher gross margins than our overall existing portfolio by design. And so if you look out over the next 5 years, I think the most significant driver in GP appreciation will really be associated with successful new product launches.

Okay, and then finally, just given the presentation of some of the early data on Biogen Idec's longer-acting Factor VIII product this summer, I was wondering if you had any updated thoughts on kind of how that product stacks up against your existing product and kind of what you've got in your pipeline for your longer-acting product.

I mean, I don't know that our views change from what we've communicated previously. Obviously, it's still early on the Biogen Idec trials, limited number of patients. But already, we know that in terms of frequency of dosing, it's been reduced, I think, in terms of the current expectation versus the original goal. So already the gap and, therefore, the added utility of extended half-life has already been shortened significantly even though it remains very much in the early stages of the clinical development. So we've talked about that before. I don't know that there's anything new there. We continue to believe the evidence by our own internal products that there is an opportunity for longer shelf life or longer half-life products, but still early. Mary Kay, do you want to add to that?

Mike, I would just add, there was no surprises in the data that we saw, and we expect to enter our Phase I clinical trial here before the end of the year.

Okay, and then just one final question. Given the increase in your receivables days, particularly outside the U.S. and I guess the comment in the Q&A about the Spanish, I guess, receivables, is there any risk that you'd have to write down any of this money that you're owed from some of these countries with fiscal issues?

Well, yes, I mean I think that risk is out there for all of us given the current situation. But historically, while the governments have paid on a longer timeline in Spain, Portugal, Greece and Italy, they have paid. I mean Greece, I think, is a bit more of an acute situation, and we did take a charge in the second quarter of last year to recognize the valuation on the bonds we received in lieu of payment at that time. So that's a risk we monitor very closely. We worked very closely with the local teams. In some countries like Italy, there is an ongoing factory program that we in the industry take advantage of, so we're less exposed there. So again, I think that is an inherent risk that we're dealing with and monitoring very closely, and we are seeing a bit of slippage there in the DSO. That is one of the drivers. But I'd also tell you, of that 4 days, FX as the euro has appreciated over the last year, that tends to drive the DSO up just based on how the calculation is done. So FX, in and of itself, is contributing a bit of that 4-day increase.

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

Just a quick question here for Bob. On U.S. Plasma Proteins, it was a little weaker than we expected in the quarter. I guess my question is, given the IVIG stabilization and what I would imagine would be U.S. stabilization in your Antibody Therapy business, I guess I was surprised to see Plasma Proteins being a little weaker. And I wonder, is that simply utilization of albumin? Or is that pricing getting a little softer within that segment?

Yes, I can take that, David. First of all, internationally, Plasma Proteins was up 20%. So very, very strong. I think as Bob mentioned in the prepared remarks, ARALAST, we were on a backorder situation which was temporary in nature, and we are seeing no impact to user demand given the reconstitution device that we are providing an alternative for our patients with going forward. So that is a result here as we go forward. Also in FEIBA, I would mention that sales were down in the U.S. close to 10%. Really, we've seen a significant increase in Medicaid patients. I think going back a couple years, our Medicaid population on FEIBA was in, call it the 40% to 50% range and now that's ramped up to about 60%. And given healthcare reform and the increase we're seeing in Medicaid rebates, that had a significant impact on our overall FEIBA sales in the U.S. That was really what happened in the quarter. It was more U.S. focused and on those 2 products, FEIBA and ARALAST.

And Mary Kay, maybe as a follow-up on the Medicaid side. I mean since healthcare reform and the implications on pharma, what have the changes been in terms of access under the 340B Program across the organization?

On 340B, we are seeing more hospitals elect to be 340B. As you know, that was part of our healthcare reform impact that we took last year, and that will grow as our 340B sales grow going forward, but that's pretty much in line with our expectations.

Okay. And just one last question internationally. There was some stabilization there, but can you update us on any specific tender processes, either won or lost in the last 3 to 6 months on OUS recombinants?

We did have some wins in the second quarter. It was, I would say, in the $10 million to $15 range in terms of international sales. We wouldn't provide what countries those were.

Rick Wise with Leerink Swann is on the line with a question.

Bob, both of you have talked about the Med Products integration. Where are we in the process of completing that? Will we see at some point operating margin benefits? And Bob, you mentioned the offset this quarter from pension, and I missed the second point, but is there a point when those factors, those drags go away and we get a net benefit?

Let me take the first part. Bob Hombach will take the second part, Rick. Yes, I think some of the operational leverage that I commented on my prepared comments was really associated with early-stage efficiencies derived by the Medical Products integration. But as I think I've commented previously, these are benefits that are going to be incurred over time. It will be more evolutionary in nature. It will be material, but there's not going to be a big event or a big pop where you'd see it, but we already are getting efficiencies, which as I said, was the basis of my comment. And those are going to continue out over I think a multiple year period of time. Bob, will you take the second question?

Yes, so within the issues that I highlighted, we talked about the benefits we are getting from the actions we announced back in January being offset by both pension and the pharmaceutical drug tax, particularly in SG&A. So that's the other big one that's impacted us this year.

Right, and I wanted to follow up on just one other point back to the actually to FX on the new product front. I wanted to make sure I understood how big the Sub-Q opportunity is in your mind as you launch and what the incremental impact could be. I've heard a variety of estimates of how big Sub-Q is as a percentage of the total market. I'd be curious to hear that. And maybe just a little more follow-up on the home hemo side, Bob. Can you help us understand what the delay has been? Is it a technology issue? Has it been securing IRB approvals to start the trial? And can you give us any more color on the trial itself? How long it's going to take to complete and possible timelines to approval, just to update us?

Let me jump on the second question. Mary Kay, you can maybe address the first in response to Rick's question. There really hasn't been a significant delay on the HHD from what the expectations we've set all along. I mean this is a complex system, a new system that's being developed, and there's always challenges on the timetable. But actually, we've been very pleased with the pace of development with our partner DEKA to get to the point, as I said, we'll be starting the clinicals very shortly in the U.S., which is basically in line with -- so no significant deviation from what we've messaged from the start. And because it is a totally new system and not one that's an adaptation or modification to an existing system, you clearly want to have a high confidence level on all operating aspects of the system. Even though it's a clinical trial, you're putting a patient on the system, and we want to be as confident as we can be that we've addressed all the issues. So as much as anything, Rick, I think it's about being cautious and disciplined and rigorous about how we do this. But again, just to reinforce, I mean we have not incurred a meaningful deviation from the timetable that we've communicated from the start. I don't know if you want to add to that, Mary Kay, or address the first part of the question or both.

Sure. I'd also add Rick that we are in the process of identifying and selecting patients for the HHD trial, which as Bob mentioned, we're going to start in the coming weeks. It is a trial that includes 24 patients. It's a 10-week trial. We expect it'll take about 6 months to complete the trial.

Let me just add to that, and maybe just a higher level of perspective on this aside from the timing of the clinical trial. We continue to be, if anything, even more encouraged about the opportunity that exists with the whole area of home dialysis, whether its PD or HHD. I think this is one where the external environment that we talk about all the time is presenting challenges. It's an area that provides a significant opportunity for us because whether it's lower cost, enhanced patient convenience, and we believe particularly in the case of the home HHD, enhanced clinical outcomes, this is a product that I think is it will benefit and a therapy that will benefit by the external environmental pressures and changes. So we continue to be very encouraged by that. Okay, Mary Kay, back to you then.

Yes, on the Sub-Q question, Rick, we estimate today that the global market's anywhere in the range of $5 billion to $6 billion for IVIG. And today, the Sub-Q market has about, call it, 7% to 8% share of that global market. Remember that Sub-Qs are really approved for use in primary immune deficiency, and primary immune deficiency represents about 25% of the overall global market. And within PID today, about 30% of the usage is Sub-Q. So you can kind of draw your own conclusions on the size of that market and the potential for Sub-Q and HyQ going forward.

And you all know this, the constraints to expansion of the Sub-Q segment as much as anything has to do with the administration complexities and inconvenience incurred by patients in terms of multiple injection sites and so on, which then of course gets to the heart of our HyQ program and our recent regulatory submission in that regard. So again, our longer-term view, and you all know this, is that when that gets approved, it will be an expander to the Sub-Q segment significantly.

Got you. And just a tiny follow-up. The Sub-Q launch is reflected in your numbers and on the home hemo, I forget, have you said to us when you hope to get approval, actual final approval and launch?

Yes, Sub-Q will launch in Q3 and that's included in our guidance. And in terms of HHD, Rick, we expect to get CE Mark next year in Europe in 2012. We will have to do another trial that we're planning to do in Canada. The Canadian trial as well as the U.S. trial we're doing here will be used to support a nocturnal indication filing in 2013 in the U.S.

Our next question comes from Matt Miksic with Piper Jaffray.

I got just a follow-up on one of the other topics you were just talking about, Sub-Q. Just, Bob, to be clear, and, Mary Kay, you mentioned a planned launch in Q3 for Sub-Q. Without approval in hand, you've been talking about this as being imminent for a while. Can you maybe just provide a little color on your level of confidence on Sub-Q? And then I've got a couple of follow-ups.

Well, look, it's not a guarantee until you get the approval. I think we're very confident we'll get approval soon. And "soon" and "imminent" means like very soon and very imminent. But until you have it, you don't have it, and that's the best I can do.

Okay, that's helpful. Okay, I realize it's tough to predict, I think, the FDA. The trends in the pump business, just a follow-up on how things are going in infusion systems, I saw some strengths relative to our estimates in the quarter, and yet you're still looking for flat growth this year. I think last quarter, you said maybe flat to down. So I guess 2 questions here. Is this a modest improvement in outlook? Or is it that you're just really holding the line on outlook given what's the process you're going through with COLLEAGUE?

A big piece of it is, and Bob and Mary Kay can add to this, is the comps because we launched SIGMA in the second half of last -- or at least the significant ramp-up. So as much as anything, the guidance and percentage increase in the second half is more associated with the strength last year. Of course, any time you're launching a product, you kind of get a bolus effect upfront. And so I think, Bob and Mary Kay, would you add anything to that?

No, I think that we had the strongest quarter this quarter that we've had. We had a strong back half last year. So the growth rate I think will be moderated and so...

I think the key takeaway on this, as Bob commented earlier, is that the device is being very well received in the marketplace, and we're very pleased with that. So we continue to make very good progress in converting the COLLEAGUE base too soon [ph].

Okay. And then one on recombinants, similar I guess but going the other way. 3% constant currency growth in Q2, 2% in the first half. Comps getting significantly easier in this case in the back half. Does your low single-digit outlook contemplate any other potential risks to the back half macro or OUS market-related and so on? And then maybe just looking beyond the back half, is low single the right the number for that market? Or do we see some moderation and recovery going forward?

Yes, a couple things, Matt. I'd say starting with the U.S., I mean I think if you look at the rolling 12-month data on PPTA, that the growth rate has moderated in the U.S. across the board, basically. And so we're sort of in line with that in the U.S. Outside the U.S., we are anticipating given the results of the Australia tender, which was recently announced, where we will not be one of the 2 providers for recombinant Factor VIII going forward. There's a 12-month transition period, so there's a little bit of uncertainty about how this moves forward. We do expect a negative impact in the back half of this year. The majority of the impact, though, will be realized in 2012 related to Australia, so that is reflected in our guidance. But longer term, as we mentioned in my prepared comments, we do see nice acceleration adjusting for the U.K. tender outside the U.S. so far this year, and we would expect other opportunities to continue to emerge. We're very excited about getting ADVATE approved already in Brazil, but in Russia and China over the next 12 to 18 months, and so emerging markets, I think, continue to offer a nice opportunity for growth for us.

And, Matt, I would just add just so you have Australia for us was about a $75 million business in recombinant.

Last year.

Correct.

Our final question comes from Sara Michelmore with Brean Murray, Carret.

I'll just throw in a couple pipeline questions, if I can. Just on Alzheimer's, could you just give us an update on the Phase III enrollment? And I think you mentioned last quarter that there had been a manuscript submitted on the Phase II Relkin data. Just if you had an update there?

Sure, Sara. Alzheimer's, we did complete enrollment in the second quarter. We've enrolled more than 360 patients, which was required. And so with an 18-month follow-up, we expect to complete the second Phase III the end of next year. And in the second half of this year, we'll start the second Phase III, and we'll keep you posted on that. In terms of Dr. Relkin, he did submit his manuscript on Phase II data to a journal in, I think, the end of the first quarter. And once that journal is accepted for publication, it will be published. Other than that, we can't really control the timeline of that. We would expect that hopefully before the end of the year.

And any update on when we might see data from the recombinant Factor IX program?

Recombinant Factor IX is in a Phase I/III trial, which will end next year in 2012, so it'll be probably sometime before the end of next year that we'll have data available.

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