百特醫療 (BAX) 2002 Q2 法說會逐字稿

Operator: Good morning, ladies and gentlemen. An welcome to Baxter International's second quarter cash flow and earnings conference call. Your lines will remain in a listen-only mode until the question and answer segment of today's call. At that time, if you have a question, you will need to press the number 1 on your touch-tone telephone.

This call is being recorded by Baxter's permission. If you have any objections, please disconnect at this time. A replay of today's conference can be heard by dialing 888-211-2648. Or 703-925-2474, and entering the pass code of 229837. This replay will be available immediately following today's teleconference until July 28th of 2002.

I would now like to turn the call over to Mr. Neville Jeharajah, Vice President of financial planning and Investor Relations at Baxter International. Sir, you may begin.

Thank you. Good morning, everybody. By now, I am sure you have seen a copy of your press release for the second quarter of 2002. As the press release indicates, comments regarding forward-looking statements and [ Indiscernible ] Actual results could differ materially from our current expectations. Please refer to our SEC filings for more details. Now let me introduce Harry Kraemer, Chairman and CEO of Baxter International. Harry?

Thanks, Neville. Good morning, everyone.

Joining me today are Al Heller, the senior Vice President and President of our renal business, our chief financial officer Brian Anderson, our corporate treasurer, Steve Meyer, our corporate controller doug Shoemare, our general coin, Tom Sabatino and also joining us today is Jean Reed, our corporate secretary as well as our corporate governance guru.

Given the extreme volatility in the stock market during the last several months, and in Baxter today I decided to change the focus of the conference call.

Today what I really want to focus on is making sure that every Baxter shareholder understands that the investment that they have in Baxter is a investment in a company with extremely high values, strong corporate governance guidelines, a unique position in the healthcare industry, a company that will make its commitments, and I'll let you decide what your investment is worth.

In terms of the topics today, I would like to discuss the following: First, a quick summary of the financial results and I really want to try to make sure that between Al, Brian and I, we have complete clarity, transparency, and eliminate any confusion that may be out there related to the quarter, related to the second half, related to the year, related to what it means. We'll make sure we get into that. And we'll stick around as long as you have questions. I don't care whether this call is an hour or 3 hours. I really want to use the opportunity to make sure there is complete clarity on what's going on.

I also want to use the opportunity to talk about Baxter's values and corporate governance. I want to talk about our overall position. We are going to highlight each of the businesses and since I'm fortunate to have Al here today we'll focus a little bit on the renal business and some of the challenges and opportunities there Brian will go through some of the specific financial details. And we'll go through the outlook.

During the quarter, a couple things of note. We successfully closed the acquisition of Fusion Medical which was the acquisition of a company that will significantly improve our position within biosurgery we also announced the acquisition of ESI Lederle.

We also submitted our Biologics license application to the U.S. FDA for marketing approval for our next generation plaza -- Plasma/Albumin Free Method recombinant Factor VIII product which was exactly on schedule by the end of the second quarter. We obtained the approval in Germany for our tick-borne encephalitis vaccine. We obtained European regulatory approval with our partner Cerus for the INTERCEPT platelet system disposal sbl did -- disposable set. We initiated our Phase 3 clinical trials for the next generation IGIV. In terms of the folks highlights, I assume everyone had a chance to look at them, sales for the quarter were clearly disappointing with an increase of only 8 percent. Including the impact of currency, sales would have been 9 percent.

But the bottom line is, as a result of issues within renal that Al will articulate in a few moments, as well as shortfall in some of our plaza in a products, particularly albumin and the fact that we were constrained in IGIV, the overall sales growth in the quarter was 8 percent, 9 percent before the impact of currency.

So there is no confusion, we still believe that we will achieve our goal that we set out the year of growing our sales in the low teens. So there is no confusion.

Second of all, although the sales were short in the quarter, and depending on your estimate, it's 50 million, 60 million, 70 million, choose your own forecast, the fortunate news is that virtually all of the sales shortfall were in our lower margin products. Which was exactly the reason despite the sales shortfall our gross profit ratio actually improved by 130 basis points in the quarter and even though we were able to increase our R&D by 18 percent, we were -- we were still able before the charge to generate an earnings per share growth rate of 18 percent, which is something that I think again when you take away the charge which we'll get into in some detail by Brian a little later, we were able to not only generate an EPS growth of 18 percent before the charges, we were able to increase the operating margin 1.5 percentage points to 20.2 and as Brian had mentioned earlier in the year, our commitment is to generate an operating profit ratio or operating margin in excess of 20 percent for the full year and that is something we will clearly do given our performance in the second quarter and the first half of the year.

Our net income actually declined by 21 percent when you take into account two issues that Brian will get into more detail later. Number one was the ip R&D charge related to Fusion Medical. If you remember, Fusion Medical cal cost us roughly $1630 million and roughly 30 percent of it, or 50 million, was required to be a one-time in-process R&D charge that came in this quarter.

The second piece and again, this is a little consistent with making sure no matter what we recognize changes as they occur, w50ed two investments in publicly traded companies, and to save you time since they are publicly traded companies we are not going to disclose what the companies, the impact of that was for us to reduce our minority investment balance on our balance sheet by roughly $70 million pre-tax and again, up front, to eliminate any confusion, in this crazy market unlike some companies that have several billion dollars of minority investments and are taking hundreds of millions of dollars of charge as a result of them, as a result of this write-off, the continuing remaining asset value of all minority investments that we hold is $70 million. Not 700, not 7 billion. 70 million. Which we believe as well as our outside auditors believe is something that is properly recorded at lower of cost or market. That's where things stand related to the charges.

If you exclude the charge, our net income was up 18 percent. And overall, from a fundamental ongoing basis, we had a good quarter, good enough in my mind, operationally, that I feel very comfortable that we will achieve our full-year commitments of number one sales growth in the low teens, number two earns per share growth in the mid-teens, and generating more than $500 million of operational cash flow.

Now, before we get into a lot more detail related to the businesses, just given everything that's gone on over the last couple months, this is sort of my shot of making very clear how we operate as a company, what you can expect, and maybe what you shouldn't expect from Baxter. Clearly, a tremendous amount of what has gone on in the marketplace surrounds an overall crisis of confidence. I believe that when I take a look at Baxter, I believe Baxter is extremely well positioned and a large part of this, I believe, is our shared values that we have talked about in the past as well as the overall level of our corporate governance guidelines. First related to our shared values. As you are aware, and I have gone through this at several of our annual growth conferences, Baxter's vision is to become the leading global provider of critical therapies for individuals with life-threatening conditions. But it's not just about attaining our vision.

Equally important is how we get there. And interestingly enough, this is not a set of values we have come up with post Enron. This is something we have been doing as a company over the last 10 to 15 years. How we conduct our affairs in the process and the results we deliver. These are the key factors that will advance Baxter toward being recognized as one of the most admired companies. Baxter continues to be a company focused on living these values as well as achieving our goals and our commitments. Baxter's shared values are the foundation and principles by which all 48,000 team members around the world operate. I have discussed these shared values with you before, but particularly in this kind of environment, let me summarize them once again. Respect, responsiveness, and results. These values are instilled within our culture.

We're all team -- where all team members act with the highest degree of ethics, integrity, honesty, open communication, and the ability of every team member to constructively challenge one another to make sure that we are always doing the right thing. The only way to ensure that we live our shared values as a team is by making sure that we have strong corporate governance guidelines including business practice standards, which are followed by every individual, those at the board, at the corporate level, at the regional level, and at the local business level in every country, in every business, and every function in which we operate.

I'm sure most of you are aware of this, but I think it is important to stress that Baxter's board of directors and executive management team take our responsibilities very seriously. In terms of corporate governance, I know there's been a tremendous amount of air play on this. But I want to assure every shareholder that I have the opportunity of talking to that I believe that Baxter and our board of directors has an extremely strong set of corporate governance guidelines that has served the company well over the last 15 to 20 years. And it includes and is a very integral part of how our board operates.

Our corporate governance guidelines define the scope and parameters of the board's responsibilities, and address areas such as board composition, membership criteria, committee structure of responsibilities, effective operation, fiduciary oversight, strategic and succession planning and social responsibility.

First of all, on the issue of director independence, this one's actually pretty easy. I am the sole inside director in the company. All of our other directors are 100 percent independent. None of our directors have business or financial interests that create a conflict of interest or related party transactions. We have 5 active committees of the board, all of which are comprised of independent members. That means that I am not a member of any active committee. Each committee of the board meets numerous times a year. Baxter's audit committee meets frequently and operates independently. At each meeting the audit committee holds an executive session without my presence or without the presence of any Baxter executive so the board conducts one-on-one meetings with both our outside auditors as well as our internal auditors.

Another topic that I think has gotten a tremendous amount of air play over the last couple of months which I find to be absolutely amazing is the number of companies that have made investments of hundreds of millions of dollars that either the board's not aware of, the management's not aware of, nobody seems to know what the Hell is going on!

Interestingly enough, as the CEO and Chairman of an $8 billion company, any investment that I want to make over 9.9 million requires the approval of the finance committee of the board of Baxter, and if the investment exceeds 50 million, it requires approval of the entire full board of Baxter's directors, absolutely no exceptions. And interestingly enough, since being the CFO nine years ago, not only I do not mind that, I actually appreciate it because if I can't convince 12 external outside independent people that something makes sense, we probably shouldn't be doing it. In addition, we have a public policy committee that oversees matters such as our quality and regulatory affairs, government affairs, environmental health and safety record, our employee relations matters, and our Baxter foundation and best citizen initiatives. We take a tremendous amount of pride in our sustain ability reporting.

We just issued our third annual report. I would encourage all of you to take a look at it because it is consistent with our focus of our triple bottom line reporting in terms of economics sustain ability, social sustain ability, and environment sustainability. The public policy committee also oversees and appoints the members of our corporate responsibility office which has been in place for almost 10 years and is currently chaired by Dave Drohan.

We have a Vice President of Baxter gretchen winter whose full-time job it is to interact with the corporate responsibility office and the public policy committee to make sure that we are setting an example for not only the 48,000 individuals within Baxter, but for people around the world. The corporate responsibility office develops and communicates Baxter's business practice policies and procedures, monitors compliance with the policies, and trains every team member in using our corporate policy guidelines.

We also have an annual certificate of compliance that requires thousands -- and I said thousands -- of Baxter team members across businesses, countries, and functions around the world to annually reaffirm their commitment to the company's business practice standards by completing and submitting the business practice certificate of integrity and compliance. And the statements and the comments and the recommendations that come out of that on an annual basis strengthen the overall business practice of the company on an annual basis. clearly at Baxter, effective corporate governance means behavior that is guided by a system of accountability and responsibility that leads to strong performance and ultimately increased shareholder value. And personally, I believe this will have a significant amount to do with the further increase in our stock price going forward.

Jan Reed is with us here today. If you have further questions or want to get into the details, please feel free during the Q & A period. Most or virtually everything that has been talked about whether it's the New York Stock Exchange, whether it's the business roundtable, whatever it is, not only is not something we have a problem with; we're already in compliance of it. And in some of the discussions that are floating around related to signing this by the CEO, CFO, Brian Anderson and I are not only prepared to sign whatever is necessary for this year; we have been doing this for the last 10 years. And have absolutely no problem. In fact, I would argue that anybody that does have a problem, we ought to question whether we ought to be investing in the company. Not that I feel too strongly about that one.

Turning to Baxter's unique position in the healthcare industry, this one I think is important because when I think of our shareholder base today there are some shareholders that have a very clear understanding of exactly who we are as a company, what we're doing and where we're going, and on the other hand, there are other shareholders that it's clear to me that are a little confused in terms of how we differ from drug companies, device companies, et cetera.

Now, similar quick background most of you are aware of: First of all, in terms of the healthcare industry, I cannot think of an industry over the next 10, 20 or 50 years that will be more attractive or have a higher growth rate than healthcare. This growth is being fueled by a combination of factors, including the growing population and the unprecedented and explosive growth in medical conditions that occur more frequently and grow more acute with age.

The greatest population growth is occurring in developing countries, places like China, India and Latin America where many people are life-threatening diseases currently go untreated with or are undertreated. This is due to the lack of resources in these countries to provide broad access to quality healthcare.

As economic expansion continues in these markets and the economies of these continue to develop, they are spending on -- their spending on healthcare will continue to increase. As these trends continue, the demand for products, therapies and services that backs Provides will continue to increase. And given Baxter's global presence with more than 50 percent of our sales outside of the United States, Baxter is uniquely positioned to meet the growing healthcare needs of patients and customers in high-growth markets around the world.

Clearly, while several issues are adversely affecting the healthcare industry today and I know I'm biased, I know I'm very biased, Baxter is uniquely positioned. Some of the market concerns that are out there today include FDA quality scrutiny, a slowdown in product approvals, patent ex-separations, productivity, and concerns about mounting pressure on pricing and reimbursement.

I really want to take a couple minutes to go through each one of these and I would really encourage you to challenge all of this in the Q & A in terms of what really does differentiate Baxter. I believe that Baxter's competitive advantage can be evidenced by our unique blend of technological expertise and core competencies of significant global presence, manufacturing capabilities and capacity, strong quality foundation and regulatory expertise, as well as our relationships with patients and customers.

As we continue to develop our leadership positions in the critical therapies we are involved in today, we will leverage our capabilities across biopharmaceuticals, pharmaceutical, devices, supplies, services and information. And we will move into new areas that logically build off or expand on our core competencies so rather than talking about are we going to become a bioPharma company, a drug company, a device company, we are going to continue to be a leader in critical therapies and a leader in critical therapies had better have capabilities crossing every one of those capabilities if in fact they are going to be a leader.

Our global manufacturing network is a key competitive advantage that allows us to provide cost-effective high quality products. Today, we are the leading developer of products and technologies that collect, separate, and store blood as well as technologies related to the fractionation of therapeutic proteins, recombinant protein manufacturing, plastic container and sterile fluid technologies.

At Baxter, quality has always been a key focus and we will continue to operate with high quality and in collaboration with regulatory agencies as we have done over the last 71 years. Because of our quality manufacturing, in contrast to a number of companies who have been operating under consent decrees, we have been able to provide continual supply of product that offers critical, life-threatening therapy to patients. This is in no way to imply we are perfect.

We have definitely had quality issues, and have been working diligently to ensure that we meet and in fact exceed the requirements of our patients, customers and regulatory authorities. Most notably were the challenges we faced late last year with our dial identifies where we took immediate action to discontinue the manufacturing of dializers and work with appropriate government agencies and ministries of health to review the facts and compensate the families affected by this incident. In fact, we have good news in this area that Al will get into in the renal discussion.

Overall, we have had a strong track record as it relates to quality and the commitments we have made on product approvals. Over the last several years, we have been the recipient of many quality awards including the distinguished Shingo prize for excellence in manufacturing.

As you may also know, Baxter does not have significant patent expiration exposure. Baxter's sales are not dependent on novel drug formulations. Instead, our competitive advantage is linked to our sophisticated, proprietary manufacturing capabilities which are difficult to replicate and require significant capital investment to maintain and expand as well as our quality expertise. I get asked all the time what the impact of patents expiring are and the answer is, it is virtually zero. There is no patent that will expire in the next 5 years that will have any demonstrated impact on our ability to achieve our commitments. Very different than every other pharmaceutical company I'm aware of.

In addition, many pharmaceutical companies continue to face fundamental challenges including an inability to improve productivity. As we have discussed in the past, Baxter has and will continue to demonstrate significant productivity improvements as evidenced by the improved yield and cycle time reductions we are achieving in our manufacturing operations. Many of you at the end of last year questioned and I think it was a great question, how are you going to grow recombinant in the year 2002 if you are not going to have additional capacity coming online?

Well, as you are aware, a recombinant grew almost 30 percent in the quarter, we expected it to grow at least in the high 20s fort next several quarters. That's exactly due to the yield and cycle time and productivity improvements I'm talking about. As a demand for healthcare continues to increase as I described earlier, the growing concern is who is going to pay for it. That's why we are focused globally. That's why we are focusing having the best cost. That's why we are focused on only focusing on things that are critical. Many pharmaceutical companies generate 5 to 6 percent of their annual sales growth from price increases and this is a trend I find impossible to continue in the future. However, the contribution of price increases to Baxter's annual sales growth in any year over the last 20 has been virtually sear Roy.

I I think this is absolutely important the number of people on an average day that are asking Mary kay and Neville and I what will be the impact of farm sued cals being covered under Medicare on Baxter the answer is virtually zero because the great majority of our products are already covered under Medicare. Very important, I believe, from a shareholder perspective. At the same time, given our global leadership and operations, Baxter has a very strong cost position which allows us to generate the best costs in the great majority of our products. And in fact, in over 80 percent of our product sales, we have the best cost manufacturing position in the industry globally. This is truly a competitive advantage in today's marketplace and will become even more so, I believe, in the future.

So in summary, given our strong set of shared values, very strong corporate governance that's been in place for many years and the unique position of Baxter in the healthcare industry, I believe we are well positioned to generate significant shareholder value on an ongoing basis. I am confident that we will achieve our 2002 commitments, and I also believe we are in very good shape to position ourselves for 2003 and beyond.

Now, with that said, let's get into a few numbers. First overall, then I'll go through a couple of the businesses and turn it OVER TO Al for renal. Sales in the second quarter totaled 2.022 billion and were up 8 percent. Foreign currency had a 1 percentage point impact on sales growth, that is excluding foreign currency, sales growth in the second quarter was 9 percent. Total U.S. sales were a billion 2 million which is an increase of 7 percent for the quarter. International sales were 1 billion 20 million, which is an increase of 10 percent for the quarter. Foreign currency had a 2 percentage point impact on international sales. Said another way, excluding foreign currency, international sales increased 12 percent or almost twice the U.S. sales growth. Year-to-date sales totaled 3 billion 972 million an increase of 10 percent. We continue to expect to meet our commitment of low teens sales growth for full year 2002 given continued strong sales in the Medication Delivery business, continued strong sales growth of recombinant as a result of continued improvement and yields and cycle times as I mentioned earlier, and the increased sales and IGIV given increased capacity in the second half of the year.

Now let's peel the onion a little bit and go by business. First of all, BioScience. Q2 sales for total BioScience segment totaled 732 million and were up 7 percent at actual rates. Foreign currency had no impact on tow total BioScience sales. Year to date sales for total BioScience totaled 1 billion 478 million and are up 12 percent. U.S. sales in the second quarter were 368 million and were up only 2 percent. As I stated earlier, U.S. sales growth was primarily impacted by lower albumin sales and the fact that we were capacity-constrained in the second quarter for IGIV. Q2 international sales of 364 million were up 12 percent, excluding the impact of foreign currency Q2 international sales increased 13 percent. A -- at constant rates, Q2 Fenwal sales were up in mid single digits and the rest of the BioScience business was up in high inning single digits for the quarter.

In terms of Fenwal, Fenwal sales growth for the second quarter at constant rates was in the mid single digits. Sales growth in Q2 was primarily driven by the continued interest in leuko-reduction. Leuko-reduction sales growth in the second quarter at constant rates was up more than 25 percent with sales in the quarter totaling approximately 40 million. In terms of our 2002 growth initiatives, we continue to expect 5 10-K approval of Alex by the end of this year and we also expect to begin European clinical trials by the end of 2002. In addition, we continue to make excellent progress with our partner Cerus Corporation in the development of INTERCEPT Blood Systems for the pathogen inactivation of blood components intended for transfusion.

We recently received European regulatory approval of the INTERCEPT platelet disposable set and we continue with the process of self CE marking the illumination device. We continue to be confident in a successful launch of this product in the second half of this year. BioScience sales growth in the second quarter was in the high single digits at constant rates.

While we continue to see very strong growth of recombinant Factor VIII which was up almost 30 percent in the quarter, as well as strong sales of vaccines and biosurgery, our plaza in a products as I mentioned earlier declined and were down by more than 10 miles an hour [ plasma ]. There is obviously been a lot of discussion related to the hemophilia market and product supply some of which Thomas Glanceman discussed at the call when we announced the ESI Lederle acquisition so I'll give you a quick summary of this as most of you know, one of the key growth drivers for BioScience continues to be Factor VIII.

Last month, we reviewed with you the overall market dynamics and growth drivers. However, in the short term, the driver of growth will be the normalization of demand as the marketplace has been severely undersupplied. Given the reduction of approximately 600 to 700 million ak tft units of product in the marketplace last year, elective surgeries were delayed. Many physicians reduced surgery regimens and the transition from plasma to recombinant Factor VIII products was postponed. However, by 2005, we believe that the overall market for Factor VIII will grow from less than 3 billion units in 2001 to more than 5 billion units. This increase of more than 2 billion units includes 2 key pieces. One, an increase of approximately 1.5 billion Factor VIII units, utilized by patients in an on-demand situation.

And second, an increase of 500 million Factor VIII units utilized by children and adults on a prophylactic basis. This could be very conservative given that this assumes that only 15 percent of the total Factor VIII patient population is treated prophylacticly. Therefore, as we have consistently stated, we expect the total Factor VIII market to grow in the low double-digit range over the next several years with the recombinant Factor VIII market growing in excess of 20 percent. In fact, for 2002, we now expect recombinant sales to grow more than 25 percent as a result of continued improvements in yields and cycle times. In terms of Q2 highlights, during the second quarter, we continue to meet our key strategic and clinical milestones.

As I mentioned earlier, we submitted our biological license application, bla, to the U.S. FDA for marketing approval of our next generation ridiculous factor -- recombinant Factor VIII and the first manufacturing suite in Neuchatal Switzerland. We expect to file our next generation product as well as the first and second manufacturing suites. As you know, we continue to produce product in the first two suites of Neuchatal and expect to have more than 200 million units available by the end of this year. In Q2, we initiated our Phase 3 clinical study for our next generation IGIV product.

As you know, this is a 10 percent liquid formulation product that includes three viral inactivation and reduction steps and is significantly higher -- and significantly higher yields. As you may recall, the IGIV market is estimated to be approximately 1.5 billion, growing to over 2.4 billion by 2005 with market growth in the mid-teens. We continue to expect our annual IGIV sales growth to exceed the market growth for the next several years. And that's exactly the reason it's so important to get this capacity online in the third and fourth quarter of this year.

Also during Q2, we received approval for our sfme vaccine for tick-borne encephalitis in Germany, six months ahead of our expectations. In addition, we recently received approval for our [ Indiscernible ] Vaccine in Brazil and we recently received a two-year contract extension to provide additional doses of our vaccine to the Netherlands. We are also making excellent progress in the manufacture of the smallpox vaccine and expect to meet the commitment to the U.S. Government.

In addition, we are in discussion with other governments for additional smallpox vac even agreements which I would love to tell you about, but tommy Sabatino has sworn me to not telling you who.

In Q3, we expect to submit the European regulatory file for the next generation Factor VIII product, and for the approval of the first and second suites in Neuchatal. We expect to file with the FDA for our influenza vaccine which is produced using our proprietary virocell technology. Finally in Q3 we expect to file the ismtd N.d. with the FDA for the Alpha one anti-trip sin and initiate phase one clinicals shortly thereafter. Preclinical studs were completed in Q4 of 2001 in collaboration with our partnership, Arriva pharmaceutical.

In terms of outlook, as I stated earlier, with continued yield improvements and cycle time reductions, I now expect recombinant factor 8 sales growth to exceed 25 percent for full year 2002. Given this, and the improved sales of IGIV in the second half as we add capacity, as well as strong sales of vaccines and leuko-reduction products for the full year, I expect the BioScience business including Fenwal to deliver sales growth for full year 2002 in the mid-teens.

Now let's turn to Medication Delivery. Q2 sales for Medication Delivery totaled 817 million. Sales growth in the quarter was 15 percent. Total Medication Delivery sales were up 16 percent in the quarter. Sales growth excluding acquisitions was in the 10 percent range at constant rates. U.S. sales of 500 million grew 11 percent in the second quarter. Sales were up 22 percent at actual rates. That is, international sales growth in Q2 excluding currency was actually 25 percent. Medication Delivery sales growth for the quarter was driven by sales growth in the anesthesia and drug delivery business in the high teens.

Highlights for Medication Delivery included the ongoing integration of cook pharmaceutical as well as others. The recent announcement of the ESI Lederle acquisition which complements and broadens our portfolio while leveraging our core competencies of injectable expertise, channel strength, strong quality foundation, and long-standing relationships with anesthesiologists and critical care providers consistent with the type of things that Dave and his team talked about at the growth conference in March. The approval of a generic injectable and intravenous mix cardiac care drug used primarily in the acute care hospital center and the UK launch of [ Indiscernible ] A critically care anti-bacterial generic drug used to fight bacteria and finally, the additional of -- addition of new several drug delivery alliances with pharmaceutical partners.

For 2002, the Medication Delivery business is focused on several growth initiatives. These include continued placement of our Colleague Pump. As you know, since the introduction of Colleague in 1997, channel placements totaled 230,000 and we once again expect to place approximately 50,000 additional channels in 2002. Continued international expansion of our higher margin specialty products which different shaets us from the market and creates a competitive advantage for our business, our continued focus on geographic expansion with the goal being to provide access to our complete portfolio of Medication Delivery products and drugs to more patients worldwide, broadening our portfolio by expanding the scope of our products and entering new market segments.

For example, expending our line of drug delivery platforms and expanding the anesthesia business into the broader critical care markets, and improving operational excellence through continued cost reductions. Given these growth initiatives and the strong momentum of Medication Delivery, I expect Medication Delivery sales to grow in the mid-teens for full year 2002. With that, I'd like to turn it over to my colleague here, Al Heller to take you through the renal business.

Thank you, harry. Good morning, everybody. Let me walk you through the Q2 sales overview. Sales for raenl in the second quarter totaled 473 million, a decline of 1 percent over Q2 of last year. Q it sales for renal excluding foreign currency impact were up 1 percent. U.S. sales of 134 million were up 5 percent in the quarter. International sales of 339 million were down 3 percent. And excluding the impact of foreign currency, Q2 international sales were flat. At constant rates, PD growth was in the low single digit and HD sales were down in the high single digits. Sales from our service businesses totaled approximately 100 million with sales growth in the low single digits.

I would like to take a few moments to provide an slaings for this performance. And then discuss where we go from here. In March 2001 I expressed significant confidence in our growth potential, based on the strong growth of our service biz the recent acquisition to revitalize our business, new products to accelerate PD penetration and the identification of new growth opportunities as part of a broader integrated care strategic approach to the renal patient. Clearly I'm not satisfied with the pace of our improvement given our Q2 results.

While I'm still bullish on renal's growth prospects for the long term there are 3 issues that occurred that require me to modify my expectations of how quickly we can get renal to double-digit sales growth. First, our sales growth rate has significantly slowed down in our service businesses especially in our RTS dialysis centers. Due to the economic and foreign exchange volatility, in Latin America and Asia which is where we have our largest RTS presence, we have put on hold new acquisitions and are not expanding existing dialysis centers. This is resulting in RTS growing in the low single digits versus the historical 20-plus percent growth.

I really don't expect this growth rate to change significantly until the economic environment in these regions improves. The second issue is that the situation was clearly a setback to our HD hemodialysis growth plans. While I'm very proud. Way we handled the dialyzer recall last fall, we not only lost sales due to the discontinuation of the dialyzers, but it also has had some small spillover effect on our HD portfolio, particularly -- particularly in southern Europe. We initially converted a number of dialyzer customers but these conversions just weren't economically sustainable given the prices of the dialyzers. And this has resulted in lower-THAN-expected HD sales. Finally, while we have tipped to increase our PD patients in all of our markets, the majority of our recent growth has come in Latin America and Asia, where reimbursement is lower than in developed markets.

In addition, unfavorable currency because of the economic volatility, I mentioned earlier, foreign currency rate changes in the same markets have negatively impacted our revenues. As such, our PD revenue growth has lagged our PD patient growth. PD apparent growth has been very good. Our PD growth has been slower for those reasons. White reimbursement in these markets, our cost is lower. It exceeds our sales growth rate so we are getting' lot of leverage at the gross margin line. So that's kind of where we have and you would have thought it would have generated second quarter performance. Given that I was going to be the featured speaker on this conference call, the important thing is where do we get from here?

Let me give you specific reasons why I remain optimistic about the growth prospects for the renal business. First, the sales shortfalls we have experienced have primarily been in our lower margin HD and service businesses. Our overall profitability is strong. We are getting gross margin leverage and our profitability continues to grow.

In terms of our PD business, we continue to achieve above market growth rates with patients with growth of 7 percent over the prior year in terms of patients. There are several indicators that give me confidence that we will continue to increase PD usage in the future. First, we have numerous product launches under way and on the horizon. We have launched home choice pediatric globally which is rapidly meeting our expectations for market adoption. As Harry mentioned last quarter, we plan to launch one of our most successful products, Extraneal, in the U.S. in the second half of 2002. And in Japan, in 2003. We are confident that Extraneal will help accelerate PD growth if these markets and we are actively preparing them for launch.

We are also launching new connectology and for those of you not fact with this connectology is the device that connects the patients to the dialysis tubing. We are launching new product in Japan and North America this year that are easier to use for the patient and enhances safety for the patients by reducing touch contamination and subsequent infection rates which may reduce patient dropoff. Second, we are continuing to communicate the positive clinical results of our Adamx study to reinforce ease of use in patient expansion. These results were just published in May in the leading nephrology journal the journal of the American [ Indiscernible ] We are communicating the results of this study to physicians around the world. Additionally in the under the circumstances, we just recently signed a new 6-year supply agreement for PD with a major chain of dialysis centers. That we believe will drive further PD growth.

In terms of HD, one of our new initiatives is our crrt offering. That means continuous renal replacement therapy. It's therapy for patients with acute renal failure and it is most profitable and fastest growing segment of the HD marketplace. During the first half of the year, we launched our new Acura crrt instrument. And accusolcrrt solution. Acura is the most advanced instrument on the market in terms of providing physicians with the most treatment options for patients. And we believe this crrk portfolio will allow to us compete very successfully in this profitable market segment.

Additionally, we are continuing the rollout of our synthetic dialyzer now available in Europe, Canada and taiwan and we are initiating test market evaluations here in the U.S. We are also progressing the development of our more advanced version which we call the sentra plus. So overall for HD we have strengthened our pipeline of new HD products and expect to launch them over the next 12 to 18 months this will improve our overall HD portfolio and allow us to compete much more effectively.

Finally, we continue to make progress in renal pharmaceutical which is as you know is a new market opportunity for us. Our drug called ee Poe max for the treatment of anemia is currently being sold in smaller countries in Latin America and asia. We will continue to introduce epomax in additional countries as well as Eastern Europe during the second half of this year. We also have begun the development process necessary to support registrations for it in western Europe and Japan. Additionally, I now expect the -- we had signed a co-promotion agreement with watsonceuticals for a drug used to treat iron deficiency. We have since closed that transaction and early indications from the marketplace are very positive following the start of promotional efforts in June.

I continue to believe that renal pharmaceutical provides us with a very high growth at very profitable market plan and we are in the early stages of building a pharmaceutical presence but I think right now, we are basically on track with where we are expected to be with the two drugs we are selling today and we definitely have enhanced our business development pipeline as it relates to pharmaceutical products and are aggressively pursuing additional opportunities. I expect we'll be announcing some additional pharmaceutical transactions during the second half of 2002.

Turning to the outlook for 2002, given the factors I started earlier particularly on economic volatility, currency, and patient mix, I now expect total renal sales growth for full year 2002 to be in the low single digits. As I mentioned previously, our current sales growth rate is just plain unacceptable. However, I continue to believe that the renal business is excellent growth potential, I expect our pipeline of new product launches to enhance our market leading PD portfolio. And enable us to profitably grow our HD and service businesses over the next several quarters. Additionally, I continue to believe that we have identified a number of new opportunities as part of our integrated care strategy such as renal pharmaceutical, our emerging crrt presence, and home dialysis, which will add to the growth of our core businesses.

We continue to make progress in each of those new areas, as well. And finally, before I turn it over to Brian to talk about total Baxter results, let me bring you up to speed on the dialyzer litigation. We are very pleased with the rapid progress we have made in resolving this issue. We have reached agreement with the families of all and I repeat all U.S. Spanish and croatian patients involved in the original deaths.

The other initial reported deaths in other countries have never been linked to the dialysis by the treating physicians nor have we been contacted by any of those families or their representatives so buys cloudy, -- so basically, all the report of deaths where we have received claims we have settled with all of those families. A small number of suits are currently pending in the U.S. for individual patient deaths. We expect that most of these suits will be dismissed due to the lack of evidence that any die lieser was used in those situations. We continue to believe that we are adequately reserved to this issue.

Here's Brian Anderson, our CFO.

Thank you very much, Al. And good morning, everybody. If you turn to page 5 of your press release, I'd like to just walk you through the details of the P&L for the quarter. Total sales growth in the second quarter was 8 percent and excluding the impact of currency sales growth was 9 percent. We continue to expect that sales will accelerate on the back half due to continued strong sales in the Medication Delivery business and improvements in -- and continued strong sales in recombinant as well as IGIV.

I'm very pleased with the gross margin rate which was 45.5% in the second quarter compared to 44.2 percent in the second quarter of last year. This was a 1 in 3 percentage point improvement. This was primarily due to the sales mix due to the very strong sales of recombinant coupled with lower sales growth in the lower margin service businesses in HD products as Al just described. SG&A performance in the quarter was comparable to last year at 19.3 percent of sales.

Big improvement over the first quarter's performance on SG&A. And SG&A actually increased 8 percent in the quarter over last year. Comparable to the rate of growth and sales. R&D expenses in the quarter was 123 million compared to 104 million last year. This is a significant increase of 18 percent over Q2 of last year. And these investments are primarily being made in our biofarm cal and vaccine businesses. -- biopharmaceutical and vaccine businesses. Operating earnings excluding the special charges that I'll discuss in a minute, was 20.2 percent of sales and the operating margin improved by 1 .5 percentage points. The improved gross margin continues to enhance our flexibility to make incremental investments in R&D and marketing programs to fuel our growth for the long term. And I continue to be very confident that our operating margin for the full year will exceed 20 percent.

Regarding the special charges, as you can see on the P&L, in the second quarter, we recorded a $5 1 million charge for in process research and development related to the acquisition of Fusion Medical which closed this quarter. Additionally, we recorded a $70 million pyramid charges on a pre-tax basis to properly reflect the significant decline in the market value of our minority interest investments in two publicly traded companies. These charges impacted EPS in the quarter by about 16 cents a share. Net earnings including these charges declined 21 percent, and excluding these charges, net income increased 18 percent for the quarter. The diluted shares outstanding in the quarter was 622 million shares.

And regarding EPS, as I stated a minute ago, the EPS declined from the charges were 16 cents and excluding the 16-cent impact of the special charges, EPS for the quarter was 48 cents or 15 percent increase.

Quickly on operational cash flow, the operational cash flow for the first half of 2002 was a net outflow of 351 million, compared to an outflow of 279 million for the 6 months period last year. While overall cash inflows were up 9 percent to 894 million, this was more than offset by increased working capital and capital expenditures primarily in our BioScience business I'll turn it back to Harry for his summary before we open it up for questions.

Thanks, Brian. During the last years -- During the last years we have focused on consistency and credibility and will continue with the disciplined approach and focus on operational excellence while at the same time while at the same time significantly increase our growth rate over time, growth that is profitable, sustainable and capital efficient. And I you've heard me talk about this before but it's probably worthwhile to give you an example. We will continue to improve the operational excellence of the company. If you think of the comments that Brian made before, we do intend, it is our expectation, that over time, we will increase our gross margin to an excess of 50 percent, will drive our SG&A ratio closer to 16 percent and our expectation is to get our operating margin with the higher level of R&D above 25 percent.

Now, in terms of growth, it will be growth that is profitable, sustainable, capital efficient and builds on that. If in fact as al mentioned earlier our sales in renal services are not as profitable, we will reduce the sales growth rate. If the albumin that we sell is at an unprofitable rate not consistent with our long term objectives, we will not take that growth. Because we will generate growth that is profitable, sustainable and capital-efficient.

In terms of our long-term objectives and in addition to sales, we expect to increase our gross margin, leverage the SG&A, grow the R&D, and be able to generate significant cash flow that, over time, even after capital expenditures, should exceed $700 million on an annual base. Given these goals, as well as our discipline and focus, all of us on the Baxter team are confident that we can take advantage of the significant growth opportunities in healthcare that I mentioned earlier and to continue to generate significant shareholder return each and every year.

Now let me be more specific about our outlook for full year 2002. Sales growth overall for the company will be in the low teens. That sales growth will have or expected to be for renal as Al mentioned in low single digits; mountain in his teens for Medication Delivery and in the mid-teens for BioScience. As Brian mentioned, we expect to have an operating margin that will exceed 20 percent. I expect our growth in pre-tax and net earnings after tax to be in the high teens, excluding the impact of the special charges discussed earlier. And in terms of the share, counts resulting from acquisitions made in 2001 as we previously communicated, we expect a diluted share count to be approximately 620 to 630 million resulted in a 2002 earnings per share excluding charges in the mid-teens.

So in summary, I believe we are all very well positioned for 2002 and beyond and at this time, Brian, Al and I and the rest of the team would be happy to take any questions on either the topics I discussed or other things that would be of interest.

Thank you. We will now begin the question-and-answer session. If you have a question, you will need to press the number one on your touch-tone phone. You will hear an acknowledgement that you have been placed into the queue. If your question has been answered and you wish to be removed from the queue, please press the pound sign. If you are using a speaker phone, please pick up the handset before pressing the numbers. Once again, if there are any questions, please press the number one on your touch-tone phone. One moment, please, for questions. Our first question is from Sheryl Zimmer of Deutsche Banc.

Hi, guys. Just a couple of questions. I guess, just starting with the BioSciences. It looks like to get to the mid-teens for the full year, you would have to grow at least 12, 13 percent in the back half of the year. And if this quarter was only 7 percent and that's with recombinant growing 30 percent, what are the changes in the back half of the year? Is it just the IGIV capacity?

I would say it's a combination of IGIV capacity, continued growth in recombinant versus the prior year quarter, and continued yield improvements in some of the other plasma-based products. I also think, Sheryl, that vaccines growth in the third and fourth quarter will be higher than the first two quarters. And also, I would expect biosurgery, particularly with the acquisition now of Fusion Medical to be higher in the third and fourth quarters. So given those -- given those impacts, Sheryl, I would expect overall BioScience growth rate for the full year to be in the mid-teens.

Okay. And then, if we could just focus in on IGIV capacity acted just that market a little bit, I understand that csl was part of the problem and albumin and one of the things that they have said is that they are focusing or they have been focusing in on IGIV. Would you be willing to talk about dynamics in that market? Pricing? I know your outlook is very positive but are there other companies that will also adding capacity? Just any color you can give us there and also if you can just remind us how big that business is? We have it at 300 million.

Okay. A couple of things, Sheryl. And again, the -- my only sensitivities obviously relate to competitors and pricing and that's when I get the look here from saab teen negotiation the general counsel. A couple things. One, you are absolutely correct. We believe that the market for IGIV will continue to expand. And in fact, if you remember at the March conference, the overall growth in IGIV is something that Glansman and the BioScience people see anywhere from 15 to let's call it the high teens on an annual basis. Very significant opportunity. There are not many people, Sheryl, with the quality capabilities -- it's very similar to the recombinant story that can produce high quality product on a consistent basis without getting involved in consent decrees. So our level of confidence that we'll be able to increase capacity is very high.

You heard my comments related to the 10 percent liquid product which will further differentiate us and there really are not many competitors that are capable of competing. I won't get into csl individually. I will say that several competitors do have the capability of providing albumin and just given the quantity of albumin in the market, Sheryl, I will tell you that the quantity of albumin in the marketplace in the second quarter and the pricing was something that definitely surprised us. So again, bad news and good news. Bad news: The pricing and the competition and the sheer capacity out there was definitely something that adversely impacted our sales. Unfortunate for you and I know how much you guys love seeing the sales come in lower. The good news is, it was at a lower margin and despite the lower margin, the fact that we were able to improve our gross margin by 1.3 percentage points gets us to an overall 18 percent earnings growth.

However, going forward, Sheryl, I break it into a few components. One, I think that the yield and cycle time related to recombinant will continue to improve and again, I know you guys were rightfully a little skeptical about that at the beginning of the year. Just don't think the guys can do it. We are. We will. It will continue. The capacity for igi -- IGIV will happen and we are actually pretty confident of that I'm not sure honestly how bad this situation is going to get in albumin. However, I kind of view it as if it impacts us, what could happen "okay, not my expectation. But what could happen? It could be a big enough impact that maybe BioScience sales growth isn't in the mid-teens. Maybe it's in low double digits. But again, given the margin implication, I do not believe that will impact our ability to achieve the overall target of mid-teens earnings growth but I'd rather not get involved in one competitor individually.

Okay. Just quick follow-up on that. It would low double digits for biosciences consider that the albumin situation gets worse or it just stays as bad as it is right now?

I would say gets worse.

Okay.

But again, let me be very clear. My expectation right now, I mean, if Glans man was here in the box rather than Al today, his forecast of what he would expect for the year is in the mid-teens. What I'm trying to do with you guys is to say, okay, what is the overall mix here? And, and again, Sheryl, I know you are aware of this, sometimes we get criticized for, my God, you know, you guys only have a 45 percent margin. Well, think about! We are only blessed we only have a 45 percent margin. Because if I had a drug company 75 percent margin, I'd have a very different problem. In fact, I'll say it to you a different way. My expectation, Sheryl, just to come at it a couple different ways, my expectation is that we should be able to grow sales in the low teens. Okay?

But think about what Brian said. The expectation over the next several years is we are going to get the gross margin in excess of 50 percent and move toward a 25 percent operating margin. So again, I think it's a renal expectation but what I don't want you guys to think is, well, geez, if the sales growth is lower, boy, how does that impact their earnings? Just do the simple math. If our sales growth over the next 3 or 4 years was only 10 percent, if we get to a 25 percent operating margin, the earnings growth is 17, 18 percent. So again, I think it's important to understand the impact of sales but I want to put this in perspective.

Okay, thank you.

thank you.

Our next question is from Glenn Navarro of Credit Suisse First Boston.

Yeah, hi, guys. A few quick questions. First for al while we have you on the line. I think when we went back to the BioScience conference back in March you talked about 10 or 11 deals that were in the pipeline. Are there still 10 or 11 deals in the pipeline? And can you walk us through why it may be taking a little bit longer to get some of these deals signed? Just pure negotiation or is it, you know, economics? And then just quickly, from Brian, can you quantify the currency benefit in the second half of the year and also can you quantify or let us know, do you currently have the capacity to buy back shares right now given the depressed levels of your share price? Thanks.

First of all, in terms of the business development pipeline I can tell you that the business development pipeline renal is just as robust as it was when we spoke earlier in the year. That nothing that was of major importance or primary target was in that pipeline as I described it back in March has fallen off. It has taken us a bit longer than I thought to execute some of these deals. And my boss Harry here has this profitable sustainable capital efficient mantra which he doesn't let up on so we are making sure we are constructing the right kind of deals. I have a couple of deals that I thought -- I hoped I would have to announce by this conference call. Unfortunately, that just hasn't happened. And but I do expect to announce a couple of deals in the relatively near future. So business development by ream looks pretty good.

Glenn, the currency benefit on the top line for the back half is -- I'd say probably one to two points of growth. Over the course of the rest of the year. As it relates to share buybacks, we have been pretty consistent in making sure that this is really viewed as an opportunity to optimize our capital structure as opposed, you know, invest in our stock. And, uhm, given that we're currently in the debt-to-capital range of about below 40 -- about the low 40s, you know, opportunistically going in and making a significant share buyback, just because the stock prices is low, is not something we would do in the context of how we try to optimize our capital structure.

Okay. Thank you.

And Glenn, by the way, Mary Kay mentioned to me that you had an announcement. So congratulations. The rumor is it's going to be Harry Navarro but I want to congratulate.

You it's Harry Kraemer Navarro! [ Laughter ] Thanks, guys.

Congratulations!

Thank you.

Thank you. Our next question is from Ben Andrew of William Blair.

Good morning. Let's talk about renal a little bit more and some of the issues there al you talked about kind of expectations in the low single digits maybe for the full year. Is that a high confidence, you know, really beaten down projection, or is this a situation that could get worse in some of these service businesses and the HD business? And kind of maybe handicap that for us a little bit? Obviously, every little bit of damage there drags down the overall corporate rate.

Yeah. Well, the issue, I think, when we spoke earlier in the year, I said high single digits in the year, I said high confidence on that, as well. A lot of it really is so dependent upon what happens with the world economy and this economic volatility that we are seeing. Two impacts there one is clearly the exchange rates that we have 75 percent of the renal business is outside of the U.S. and we have really substantial businesses in Asia and Latin America. So whereas we may get some benefit in fact second half of the year out of Japan and the Euro currency rates, we are still I think going to be have a big exposure in Latin America and Asian businesses. The foreign economic volatility is something that I am -- is a potential that would say that we -- we, uhm, would hit the single-digit numbers. The other thing is that again, we need to see an economic turnaround in order for to us continue our expansion of our service businesses. We have put a hold-on acquisitions because they are just not economically viable with the situation that's going on now as well as the purchase prices that we would have to pay for these things. We have stopped expansion of existing centers particularly in Latin America and Asia again because of the same conditions. So right now, I would say I have a high confidence in a single -- low single-digit number. But there is always the wild card out there. I don't expect it to happen. And certainly we would like to perform it better than low single digits. That's our objective and that's what the 2000 ,000 team members in Renal are totally focused on at the current time. [ 2,000 members ]

You talked about the currency effect in the second half of the year. Brian, what does that relate to for a full-year currency impact?

About 1 point.

Great, thanks.

Thank you. Our next question is from Dan Lemaitre of Merrill Lynch.

Hey, guys.

Hey, Dan.

Just to I guess just to star, Harry obviously you had a lot on your mind, a lot of things you have been thinking about in terms of some of the macro stuff that's going on out there but what I'm confused by, you have a conference call in early June. Where you talk about the Lederle deal. You clearly were well into the quarter. And given the sensitivity of so many things that are impact stock prices today, was -- were you aware that the sales numbers were headed for the single digits at that point and just didn't think of it as a big enough deal,er did the business really get worse as June unfolded and so it kind of surprised you the way the numbers rolled up?

I guess, Dan, I would say on that call, there were two major focuses I wanted to make sure of. Number one, we wanted to make sure that there was complete clarity related to the acquisition. And number two, after talking particularly to you and a couple of the other guys, there was a lot of confusion related to recombinant and that's why we had Thomas on the call related to the overall recombinant issue. If you remember, that was already during the quiet period and we were not going to talk about any particular quarter. All of the commitments we make, Dan, for the full year. And when you are asking about a surprise, there is no question that the surprise to us was related to albumin.

I think Al had given you guys a pretty good sense that there was concern related to what could happen with renal services, but I guess the way I looked at it, and maybe this is just the wrong way to look at it, number one, we have commitments for the full year. If we don't believe we are going to hit those commitments, I feel a responsibility to tell you guys. But if I was so focused related to any one quarter, then, Dan, we wouldn't be increasing R&D in the quarter by 18 percent. We would have leveraged SG&A more than growing SG&A at the sales growth. So I guess the way I look at the call was there was sort of 3 things that we owed you guys. One, was a good open understanding as to why we were making an acquisition. Number two, given the amount of concern as to what was happening related to , that seemed to make a lot of sense. But quite frankly [ recombinant ] If in fact the sales were lighter but they were in areas that we thought we would offset with the higher margin, not obvious to mean, Dan, would we communicate to you. Now, you are sitting here, obviously, feeling bad that the sales growth is lower in the quarter. But does it really I am -- doesn't really impact in my mind our overall commitment for the year. So I'm not sure what I would have communicated to you.

All right. That's fair, Harry. But, uhm, so just so we could maybe get expectations set the right way and I know you have talked in terms of full-year commitments and the like but there are some comparison numbers that get a little squirrely with BioScience up 20, what, 5 percent. Last year in the third quarter and then only 14 in the fourth. And so I'm wondering just to make sure expectations are set, is there going to be a marked differential, do you think, in the sales growth rate in Q3 versus Q4?

You know, my gut reaction is probably not, Dan. However, to be honest with you, I don't feel real comfortable talking about what the swings are going to be in quarterly sales growth from quarter to quarter. I mean, when I think of the top things we ought to be focusing on for a company the size we have, I think I've got a commitment to you guys to make sure that we make our commitment. To the extent that we have swings in sales growth particularly sales growth that will not have an impact on the total annual commitment for sales growth of the earnings, you know, my sensitivity, Dan, is, that puts me in the box of being able to predict by quarter every major business unit within the company. And honestly, as an operating person, I don't think that's a rational place to be because all that does is set you up for further disappointment.

Okay. That's fair. Let me just try one last thing and then I'm getting off and it has to did with next year and I know the October call will deal with next year. But obviously, one of those swing factors is going to be Neuchatal, the timing of Neuchatal approval both for the U.S. and Europe. Can us just give us a rough sense of when we might expect that approval -- [ Laughter ] -- and how that may in fact affect the sales progression next year?

Well, Dan, and again, you know, and I know Neville is going to go completely out of his mind when I say this, okay? But again, since I -- I -- you heard me go through this values discussion and I think you know how serious I am about it. I think you know how serious I am with this governance thing and while -- and this is sort of the two sided monster on this one, Dan? While I would really love to help you out, I mean, honest to God, I'm not being cynical. I would really like to help you out, there is a certain level of frustration here, okay? You well know that we said that we would submit the application for approval by the end of the second quarter and interestingly enough, we did. I mean, there was a lot of people who said it wouldn't happen. Guess what. June the 28th, 10,000 sheets of paper got submitted to these guys, okay? Done. And... now it's in the hands of the regulatory body.

You also know, Dan, we're producing the product and already have 200 million units available. Now, I'll let you guess when this thing is going to get approved because, number one, if I guess, likely I'm going to be wrong. And then you and I are going to have a discussion, well, Harry told us it was going to happen in x. Why did it happen in y? The reason I don't know, Dan, is I don't know.

But what's going to drive you completely out of your mind, unfortunately, is that if we don't get approval until you pick it end of Q2, end of -- you pick it, something tells me two things are going to happen. Number one, we are going to have a hell of a lot of units to sell and number two, you are probably not going to like the quarter pattern and unfortunately that's sort of life. What do I believe? What I do expect? I expect, Dan, we will do what we said we are going to do. In terms of the overall commitments. And unfortunately, you know, I have looked a little bit at this sort of crisis in confidence gap. What I find fascinating is if I tried to bucket the stuff that I'm pretty confident of, the problem is it's not enough detail of what albumin sales are going to be in the second quarter of 2002. If I do that, then we are going to set you guys up for further disappointment. And honestly, Dan, I'm not hassling you. But when I think about Greenspan's comments and the process, I think this is all part of what we need to think through. I am not going to make commitments as a CEO of a company, I am not confident our team is capable of delivering. And to get to that level of specificity by quarter doesn't make sense to me.

I hear you. Thanks.

Thank you. Our next question is from Ted Huber of Banc of America Securities.

Thanks. Harry, first, I wanted to make sure we're all clear on the revenue guidance because in the past if I'm not mistaken you guys have always talked about revenue growth rates in performance or constant currency terms. And so when you are giving these EPS targets today, are those in performance constant currency terms or are you talking now about reported growth for the year in the second half?

We are talking about a constant, ted, because for the most part, constant -- constant and actual are virtually the same. But we are talking constant. When we talk about EPS -- the only EPS I'm talking about is -- is the total company. I'm talking about at actual rates, what you would expect the total earnings per share of the company's growth rate to be. So basically, Ted, it's the way we have always done it, which is giving you guys the insight on what things look like at actual and constant rates by business and then we talk about the total company's earnings per share, it's at actual rates, what you would expect. But again, to tell you a little bit more, Ted, this year, the way it works out, it doesn't really make a very big difference earnings-wise because net-net at the end of the day, as Meyer's gone through, between our natural hedges and our hedging, the impact of currency on earnings is very minor. But maybe Brian or Steve ought to elaborate. Maybe I don't have this perfectly -- go ahead, Brian.

I don't know that there is much more to say, Harry. I think that, uhm, there is nothing different in what we communicated today than we have previously. In terms of the -- the mechanics of how we talk about top line growth expectations for the company or the businesses. The individual business units we always talk about it in terms of constant currency growth rates for the total company. It's our expectation based on the actual growth rates and we have just told you that currency would impact the total company about 1 to 2 points in the back half as a benefit, given what's happening with the major currencies primarily the Euro and yen and that relates to top line sales. Earnings per share growth as Harry just said is based on the actual results of the company and the impact of currency because of the hedging activities will be negligible on earnings.

Okay.

Is that clear?

That's very clear. Just to follow up, then, on the IGIV situation --

Wait a second, Ted. Are you comfortable with that, Ted, or is there some other concern you had about currency?

No, I want to make sure we are just talking Appalachianles to apples because obviously we are at a point where currency is turning to be a benefit for you in the second half. You look at it for the whole year and it's a slight positive.

On sales, ted.

On. On sales. That's right. But so these revenue targets that we are talking about again are constant currency. you have actually a little bit of currency benefit so the reported numbers now look like they might be slightly higher than these numbers you quoted because of that currency benefit if I understand right.

Correct. If the currencies stay at the rates they are at, what I gave you as the businesses's growth rate would be higher. You are absolutely right.

Yes.

If they stay where they are, ted. That's exactly why I have given to you a constant.

Fair enough. That's clear. So, uhm, on the IGIV opportunity, without giving away too many competitive secrets here, can you tell us these capacity expansions where they really take you? You are kind of in the $350 million range in that business right now. You want to continue to grow it in the teens. What will this capacity increase give you and when do you need to go back and add additional capacity even beyond that? I would say, chief, that what we are talking about now would enable us to double the business over the next 4, 5 years. In terms of IGIV capacity. So this capacity increase this fall doubles?

Well, with the yield improvement. Neville, do you want to add to that?

No. This capacity increase including the yield improvement that we get will help us -- [ Indiscernible ] But on an ongoing basis, as we get more plasma to Baxter's manufacturing capacity that will give us additional -- [ Indiscernible ] [ heavy accent ]

So it's not a one-step function to double capacity.

But given the Serotec acquisitions and now the fact from the result of that acquisition, Ted, we now have the additional source plasma, our ability to manufacture would be a lot greater.

Right.

Because for the most part, we don't have enough -- we are using every unit of plasma that's coming in today.

Okay. Last question, I did some analysis the other day looking at your value, your pensions. Last year you guys granted options valued at about 435 million to employees which is was a significant increase and puts you well ahead of where your peers are. That's about 5.7 percent of your revenue. Now, I know under current accounting rules, none of those will run through your P&L. I'm not going to ask you to comment on where fast b might go but could you help us understand where your philosophy is relative to options? Is that an appropriate amount for you to be paying to employees or in that form of currency or should we expect that to come down if the future periods?

Well, let me make a couple comments and then Brian may want to add to this. I think it's an astute comment, ted. What we decided to do last year was to grant an option of 100 shares to every Baxter team member in a country where it was legal to provide that which I think was roughly 42, 43,000 individuals. That was a one-time event where they ended up getting twice the number of options as a result of the stock split. That's not an annual occurrence. So when you take a look at that that is something that, you know, could happen, you know, every once in a while but I would not foresee that to be something that happens every couple of years.

Number two, when you ask philosophically, I think the way I would summarize it, ted, is that Brian and I believe pretty strongly that stock options stock options should be expensed which raises the obvious question of well, why don't we? Number one, we believe they should be ex-spensed. Number two I also believe that a great deal of what you guys do deals with comparability if you're the one healthcare company that's doing it, it destroys a little bit of comparabilities. I'm basically making the assumption that we are going to get to a sanity stage here where all options will be expensed and and we'll do that in conjunction with every other company. I would be very surprised if on average option grants for Baxter as a percentage of market capitalization or sales would differ from any major company our size. I would think it would be just about average, ted, over any period of time.

Okay, thanks.

Thank you. Our next question is from Craig Baskin of Loomis Sales.

Thank you. My questions have all been answered. Thank you.

Operator: Thank you. Our next question is from Brian DeChristopher and Mr. DeChristopher... I'm sorry... he has hung up. One moment. [ Pause ] Our next question is from Glenn Risin of Morgan Stanley.

Hi, Glenn.

I'll be on my best behavior because I know you're not in a good mood today.

You know, the funny part of it, Glenn, is I'm actually in a very good mood. I'm just really focused as I said at the very beginning, Glen, on transparency, clarity, so everybody knows exactly where we are. So I would argue, Glen, the more direct you are, the better.

good. I didn't name my baby after you so don't hold it against me.

Now, that could actually upset me! [ Laughter ]

k o so a couple of things. Can you teach me a little bit about the blood fractionation business? What I worry about a little bit is if you expand your production capacity for one protein, you basically have all this plasma which makes the incremental costs of producing different types of proteins very small so doesn't that lead to a collapse of pricing for the other therapeutic proteins? Just for example this quarter albumin you said was down. What did a recombinant Factor VIII do in the quarter? What were the pricing trends there?

Well, and again, I won't get involved in the pricing trends of each of the individual pieces Glen. But let me sort of give you the big picture. I think of it -- I think you are on the right track. I think of plasma fractionation almost in terms of a refinery. And you got different paths and the goal is always to make sure that you have at least two economically -- if you have at least two fractions, then you will make sure that overall, you're in pretty good shape.

So overall, right now, the goal would be, Glen, by increasing the amount of plasma Factor VIII sales, outside of the United States, as we convert most of what's in the United States and Europe to recombinant as that yield and those suites continue to open up, the goal would be that between plasma Factor VIII and IV ig, that the -- IGIV, that the cost would put us in a position to generate a very good overall return. And several years in the past, because albumin was being priced at a renal level, you had 3 fractions that were all sort of hoping -- helping to leverage the cost. That's the difference between when you are thinking about the cost and the price. What is happening with the available spry on albumin doesn't have any impact on the pricing of plastic in a, Factor VIII or for IGIV.

The reason I'm asking this is on the flip side of this we had heard earlier in the quarter that there was a certain competitor out there that was dumping oo IV ig or as you say IGIV in the U.S. market. And that had led to a collapse of pricing in that market temporarily. And then all of a sudden in this press release we hear about albumin pricing coming down. Can you give us some flavor about what growth was in the other fractionated proteins in the quarter besides just the albumin numbers?

I would say, chief, in the second quarter, taking into account with the higher yields of recombinant the shift of everything from plastic in a ma to recombinant in the quarter, total plasma products were including -- obviously a big part of being albumin, was down roughly 10 percent. In terms of Factor VIII let's take the roughly 30 percent growth in raekdz an say 10 percent ducks in plasma Factor VIII in the quarter, you had growth in Factor VIII overall, let's call it roughly 20 percent. [ inaudible question ] Including IGIV, I would say -- let's call it in total in the 10 percent rage. Fueled significantly by the IGIV.

Last question, do you think maybe you can outline the different acquisitions what their contribution was in the quarter and give us some guidance of what it looks like in the third and fourth?

About 50 million in rev introduce for ester and cook.

And that was all in -- So it was all Medication Delivery.

All Medication Delivery.

And then, uhm, for the third quarter what's it looking like now? With esi?

Esi depends on when we close obviously. We have submitted and we are waiting on the regulatory process as it relates to, you know, whether we get a second request or not. But I think -- Glen, I think it's fair to say we cannot again, Sabatino is here, we can't comment related to when we think we close but I think important to you, Glen, honestly is when we talk about the numbers, there is no assumption in fact numbers that we have ESI Lederle show up. The way they are going to get to it -- I am not making any assumption that ESI Lederle happens this year. That doesn't mean that it couldn't.

But the discussion we are having now has nothing to do with ESI Lederle. You basically again to be crystal clear here, the low double digits excludes any contribution from currency and any contribution from additional acquisitions?

Correct.

Thank you.

Thank you.

We'll take 2 more questions.

Our next question is from CIBC world market.

Just a follow-up to Glen' question. I wonder if you can talk about the plasma-derived Factor VIII in terms of unit growth terms. Now, I know you might not want to get into all of the specifics, but one of the things we look at you guys talked about this unmet supply or sort of very significant demand out string supply in the Factor VIII market but yet we are not seeing growth in the plasma derived part and I understand you have a constraints but you know, that business, you have had higher quarters in that business in the past. And just wondered if you could help explain what's going on there.

I think that's a fair comment, John. Let me break it apart for you. I'm not going to get into pricing, obviously, so if you know the sales, and you don't know the pricing but maybe I'll tell the units we may have a problem. That's okay. John. Here's a better way to do it, okay? Think about what's going on. As the yield has increased in recombinant Factor VIII and the cycle time and we have pretty much talked that one through, we end up with more recombinant product than we had thought we were. So the immediate reaction particularly in the the states in Europe is to sell every, single unit we can and to be able to make those conversions. Which is what we have done. Now, because we are making the conversions faster than we had expected, suddenly now, we'll have more volume to sell particularly in interContinental, Asia et cetera. Well, that, John, doesn't get turned on like later that day.

I mean, we have got it then -- we've got to then make sure because obviously in InterContinental one of the challenges we always have is to make sure that they have a continuous supply so if they view that as temporary, you know, that's a problem and if you remember, John, most of those countries in Latin America and Asia are on tender so we have to actually wait for a tender to occur before we can sell those products in some of those countries. But if you are asking me, what we would expect, what we would expect is the follow, John. Over the next several year, the fomg. Number one, we would expect to significantly increase recombinant and we are talking about numbers from let's call it a little more than a billion to think of numbers pretty close to 3 billion in terms of what we would be able to deliver. And in terms of plasma, over time, to move the great majority of plasma product, not say the great majority of tr, at least 80 to 90 percent of it, to Latin America, and Asia. That's the game plan.

Okay. So, Harry. So in the process, I mean, do you end up with product that you can't use as this quicker than expected conversion to recombinant occurred, you end up with inventory of plasma derived that you don't have a market for and are you -- are you now developing that market as we speak?

I'd say it's a very -- at the end of the days, it's a very small amount of inventory. So because we -- unfortunately, the industry has had to operate with virtually no inventory so if all of a sudden you have 3 weeks of inventory in any other industry, that's nothing. In this industry, hey, it's more than two or three -- it's more than two or three days. And again, if you take a look at the inventory, the great majority, 95% of the inventory, ends up being plasma, uhm, work in process, you know, waiting to get approval. The actual level of finished good is extremely small.

Okay. So what kind of -- what do the plasma numbers look like in Factor VIII and Immuno globulin in the second half? Can you help us with that? In the IGIV area, it looks like an awfully big jump in the second half. If we're going to get to a 15 percent type growth rate for BioScience.

Neville, what level -- Or for that business, for that matter, because I think Neville said IGIV grows 15 percent this year. Yeah. I think it's fair, John to say that IV ig would be around 3 [ Indiscernible ] Million dollars and that's about the growth rate for the entire year.

Okay. I'll work through that. The other question, we have been getting some questions, Harry, on pension plan return assumptions, that is pension asset implied rates of return and what that could mean for pension expense in the future. Can you talk about where you are on that front in terms of implied rate of return and what, if anything, will change in the future?

Sure. Brian can address that for you.

Yes. John, the rate of return assumption for this year is 11 percent, and I can tell you that our rate of return assumptions when we look at the return that we have earned in our pension plan, pick a renal period, over any 5 to 10-year period, we have always achieved our return assumptions because we're fortunate enough to have a population that is relatively young and so our investments in the pension trust really have a long tail to them.

Now, having said that obviously, the market has not performed up to anyone's expectations and as we go through, setting those assumptions for next year, we'll take a look at both the rate of return assumptions, discount rate, et cetera, and set an appropriate set after assumptions for next year's operating plan and when we share our expectations for you next year in the October call that will be a part of our overall assumptions or one of the variables implicit in setting our earnings objectives for next year.

How much could that move the needle? Can you give us a little sensitivity on that?

Just on the rate of return assumption alone, you could think of every one point having an impact of, say, 10 million after tax. But the discount rate on the liability also goes the other way. So... it's hard to kind of single out just one variable among several that impact the pension expense.

Okay. That is very helpful.

I would add, John, that the plan -- even with the market conditions we have had, as of today, our plan is still fully funded.

I'm going to wrap up here. Harry, I wondered, I know you didn't want to take a crack at the sales growth 3 q versus Q4, but would you be willing to take a crack at the EPS numbers for Q3, Q4? [ Laughter ] Kind of help us a little bit there?

I actually do feel sorry four, John. You have to ask questions you know I'm not going to answer. That's part of it. [ Laughter ]

Okay, thanks.

Thank, John.

Operator: Our final question is from Thomas Buchanan of JB Ware.

My question has been answered. Thank you.

Okay. Thanks, everyone. And, uhm, we will definitely continue to keep up to speed here. Thank you, everybody.

Thank you. Ladies and gentlemen, this completes today's conference call. Thank you for your participation. And you may disconnect at this time. Have a good day.