百特醫療 (BAX) 2006 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to Baxter International's second-quarter earnings conference call. Your lines will remain in a listen-only mode until the question-and-answer segment of today's call. (OPERATOR INSTRUCTIONS). As a reminder, this call is being recorded by Baxter and is copyrighted material; it cannot be 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, Vice President Investor Relations at Baxter International. Ms. Ladone, you may begin.

Thanks, John, and good morning, everyone; welcome to our Q2 2006 earnings conference call. Joining me today are Bob Parkinson, CEO and Chairman of Baxter International, and Rob Davis, our Chief Financial Officer.

Before we get started let me remind you that this presentation, including comments regarding our financial outlook, new product development and regulatory matters, contains 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, everybody. We're very pleased today to announce strong results for the second quarter. As indicated in this morning's release, which I think you've all seen by now, we're also increasing our guidance for the full year for all key financial parameters including sales revenue, earnings per share and cash flow. Our results for Q2 and our outlook for the remainder of 2006 are a byproduct of the momentum that is building throughout most of our businesses and our operations.

For the second quarter, adjusting for the impact of COLLEAGUE pump sales in last year's results, organic sales were up approximately 6% and we're projecting that sales on an organic basis will accelerate in the second half of the year and will continue to be driven primarily by BioScience. I think it's also very encouraging to note the strengthening of our renal business and the acceleration of growth in medication delivery.

For example, the peritoneal dialysis segment of our renal business grew by 6% on an organic basis for the second consecutive quarter. As you know, this is a higher growth rate than we've experienced for a number of years and we believe it's a result of our more focused, what we call our back to basics marketing efforts as well as our aggressive geographic expansion in key international markets.

Medication delivery, which of course has suffered from a COLLEAGUE difficulties, in addition to generic competition with Propofol and Rocephin is now poised for growth in the second half of 2006 and into 2007. While admittedly this is a result of easier year-to-year comparisons to some degree, we're also experiencing accelerated growth in several key business segments including our anesthesia critical care and drug delivery businesses.

In addition to accelerating topline growth, we continue to make meaningful progress in improving both gross margins and operating margins. This results from a combination of factors including pricing leverage in select productlines; business mix improvements, largely led by BioScience; manufacturing efficiencies across all of our businesses; and the exit from select low margin businesses. Despite the overall progress we've made in this regard over the past two years, we certainly believe opportunity still exists for further margin improvement going forward.

R&D and business development activities are also accelerating. During the second quarter Baxter announced several initiatives that leverage the Company's unique technologies platforms and further expand our global presence. Some of these include, first of all, FDA approval and U.S. launch of ultra high dosage strength of Advate for hemophilia A, making it easier for people requiring higher doses to administer Advate by reducing both the infusion volume of drug solution and storage space. The launch in Canada of GAMMAGARD liquid, Baxter's ready to use liquid 10% intravenous hemoglobin. A tender from the U.S. government for a contract award to DVC LLC to develop cell culture based influenza vaccines. Baxter will develop seasonal and pandemic vaccines using the Company's vero-cell technology and, as I think you know, has recently initiated a Phase I/Phase II clinical trial in Australia and Singapore to test a candidate H5N1 pandemic influenza vaccine.

Also, the commercial availability in the United States in the second quarter of HYLENEX, a liquid injectable formulation of recombinant human hyaluronidase that increases the absorption and the dispersion of injectable drugs and simplifies the delivery of medication subcutaneously. And finally, [ten] approvals from the FDA for Ondansetron injection USP, a generic version of Glaxo SmithKline's Zofran which is used for the prevention of nausea and vomiting. And we plan to launch this drug in both vial and premix presentations in late December upon expiration of the pediatric exclusivity period.

We're very encouraged that our level of R&D spending increased by double digits, actually 10% in the second quarter, more than twice the rate of increase of revenue growth. As our overall financial position continues to improve, we're committed to accelerating the growth of F&D spending, which for the full year 2006 will result in low to mid teams growth compared to last year.

The announcement three weeks ago of the consent decree relating to the COLLEAGUE and SYNDEO infusion pumps represents the last significant remaining legacy issue for us to address. While there remains much work to do regarding the consent decree, as I mentioned all of you on the recent call, I'm now confident that we have a roadmap to move forward toward resolution of this matter. As you all know, further terms of the consent decree, we were required to submit to the FDA a corrective action plan for their review. And I'm pleased to report that we have submitted the corrective action plan within the time frame outlined within the decree.

In addition, over the last week or so we've had four very productive meetings with the FDA on a variety of topics related to that plan. As a result of these discussions, we've reached an understanding with the agency on the remaining items that need to be addressed to allow us to initiate remediation efforts in the United States. We've also agreed to modify our current 510-K in order to ensure that it's fully aligned with the corrective action plan.

Outside of the United States our recondition efforts are going very well, with approximately 25% of the installed base of devices fully remediated. Our current timetable calls for those efforts to be substantially completed by the end of this year. We also have a significant backlog of demand outside the U.S. which we will begin filling before the end of 2006.

And again, to remind you, as I mentioned on our last call a few weeks ago, as new sales of devices for 2006 outside the U.S. were not reflected in our earlier earnings guidance, we would estimate that any sales outside the U.S. would more than offset any further marketshare erosion in the U.S. between now and the end of the year. In the U.S., as we have previously communicated, we've lost approximately 4% of the channels of our installed base over the last 12 months and that really hasn't changed materially at all in the last three weeks and we believe, as I said before, this as a relatively immaterial impact on our overall financial performance. So I'd be happy to take additional questions on the COLLEAGUE situation at the conclusion of the call this morning.

So with that, at this time I'd like to have Rob walk you through the detailed financials. And when Rob concludes his commentary then I have a few additional thoughts which I'd like to share with the group this morning. And then, as always, we'll open it up to Q&A. So, Rob, please.

Thanks, Bob, and good morning, everyone. I'm very pleased to be here today to discuss our financial results for the quarter and our outlook for the remainder of the year. As you've seen, our GAAP earnings per share for the second quarter were $0.47 compared to $0.51 per share last year. Excluding special items, our adjusted earnings per diluted share of $0.57 increased 16% and reflected better than expected sales, continued gross and operating margins expansion as well as lower interest expense.

Excluding the impact of stock option expense of $0.02 adjusted earnings per share were $0.59, which is an increase of 20% and compares very favorably with the guidance that we previously provided for the quarter of $0.54 to $0.56. We are very proud of these results and feel they reinforce the value that can be gained through disciplined execution and a focus on productivity.

Turning now to the P&L, which I'll discuss excluding special items, our organic sales growth in the second quarter of 4% exceeded our guidance which called for organic growth of 2 to 3%. As Bob mentioned, this growth continues to be primarily driven by strong sales in our BioScience business. For the first six months of the year we were able to deliver 4% organic growth despite absorbing COLLEAGUE, generic competition and the exit of low margin businesses. Collectively these items totaled approximately $260 million in lost sales.

I should note, however, that this was somewhat offset by the benefit in BioScience of the added volume associated with the American Red Cross agreement which added an incremental $100 million in sales in the first half of the year. Together the net of $160 million of downward sales pressure will mostly anniversary out of our results this quarter. As a result we do expect to see an acceleration in sales growth in the second half of the year.

Now as we turn to the business performance for the second quarter I'll discuss sales growth on an organic basis given that our guidance for sales by business is on a constant currency basis. Let me first cover medication delivery. Excluding COLLEAGUE and generic competition organic sales increased 4%. On a reported basis sales of $1 billion were down 6%. IV therapy sales increased 4% led by 10% growth in our U.S. IV solutions and nutritional businesses offset by lower single digit growth internationally.

Double-digit growth of our proprietary and generic premix drugs somewhat offset the impact of generic competition for Rocephin in drug delivery. Excluding the impact of this generic competition drug delivery sales actually increased 5% while on a reported basis organic sales showed a decline of 5%. Infusion system sales were down 17% as a result of the hold on COLLEAGUE pump. As a reminder, COLLEAGUE sales were approximately $45 million in the second quarter of last year.

Sales of our access systems or disposable sets, which are reported in our infusion systems product category, were once again up 2%, in line with overall market growth. So despite the COLLEAGUE hold we have continued to maintain a steady level of disposable sales.

Our core anesthesia sales increased by approximately 10% given the introduction of Ceftriaxone and sevoflurane as well as strong international growth for Suprane of approximately 30%. Offsetting this growth was U.S. Propofol sales which were down by more than 50% year-over-year. As a result the reported organic sales growth for our anesthesia business is a decline of 7%.

As I mentioned earlier, we expect sales for medication delivery in the second half of the year to accelerate to mid single digits as we anniversary out the impact of COLLEAGUE and generic competition. We also expect that ramp up in the sales of our anesthesia critical care business due to the continued strength of Suprane, the phased introduction of sevoflurane and the benefit from our added drug delivery capacity in Bloomington. This will result in full-year sales growth for medication delivery on an organic basis of 0 to 2%.

Now turning to our renal business -- reported sales of $516 million were up 4% on an organic basis as growth in global PD offset the decline of lower margin HD sales. As Bob referenced earlier, global PD growth continued to be in the upper -- continued to be in the mid single-digits both in the U.S. and internationally as we continue to focus on strengthening our global market leading position by partnering with governments around the world to establish PD as a first-line of therapy.

International sales for renal increased 5% driven by strong PD patient gains in Latin America and Asia which resulted in international PD sales growth of 6%. While our PD patient growth into developing markets is in the high single-digit led by growth in China of more than 25%, we are also encouraged that we continue to see sequential patient gains in the U.S., Europe and Japan. In the second half of the year we expect stable sales growth in the low single-digits for renal with PD growth continuing in the mid single-digits as we continue our disciplined focus on driving PD penetration globally.

In BioScience momentum continued with the very strong second quarter. Reported sales for the quarter hit a record of $1.1 billion, which is an increase of 15% on an organic basis. Total recombinant sales increased 12% led by Advate sales of approximately $217 million. Recombinant sales increased sequentially from Q1 by approximately $50 million primarily due to continued conversion to Advate globally and, to a lesser extent, some initial stocking orders for Advate ultra high potency which Bob mentioned earlier in his opening comments.

Global Advate conversion continues to go well with conversion totaling over 60%. We now have reached approximately 85% conversion in Europe and conversion in the United States continues to improve as we've now converted approximately 45% of our sales. As a result we continue to expect full-year recombinant sales growth of more than 10% with Advate sales approaching $900 million.

Within the plasma business, plasma protein sales increased 27% compared to last year as a result of increased volume associated with the American Red Cross agreement and improved pricing for several plasma protein including Albumin. Antibody therapy sales more than doubled year-over-year. Once again this increase can also be attributed to the incremental volume related to the American Red Cross, improved IVIG pricing and our continued conversion of GAMMAGARD IVIG to liquid GAMMAGARD. As a result we now expect antibody therapy sales to exceed $750 million for the year.

Biosurgery sales increased 14% and achieved a record quarterly sales level of approximately $80 million. We continue to expect biosurgery sales growth to be in the midteens for the remainder of the year. Finally, the decline any other sales category is related to the decline in lower margin third-party plasma sales which was somewhat offset by mid single-digit growth of our vaccine businesses.

Clearly the sales overachievement for the Company in the first half of the year can be primarily attributed to momentum in the BioScience business. We've continued to see increases in Advate conversion in both Europe and the U.S. and expect solid growth to continue throughout 2006 and into 2007 as we launch Advate in Australia, Japan and Canada over the next 12 to 18 months.

The plasma market dynamics have been consistently improving with a better balance between supply and demand and we continue to see improved performance for many of our plasma therapeutics. In addition, we continue to expect to add increased value by improving our product mix with continued conversions to premium specialty products such as liquid GAMMAGARD and FLEXBUMIN. And as I mentioned earlier, we expect midteens sales growth for our biosurgery business for the second half of the year. As a result of a very strong first half, BioScience is very well positioned to drive organic sales growth for the full year of 12 to 14% and to continue to deliver strong operating results.

Turning now to gross margin, our adjusted gross margin in the quarter of 46.5% is the highest it has been since the second quarter of 2002. Gross margin improved by 3.3 percentage points compared to last year as a result a margin improvement across all of our businesses. The primary driver, however, was higher margins in BioScience, largely the result of Advate conversion, improved IVIG pricing and improved mix. Overall we are very pleased with our gross margin progression as this is the sixth consecutive quarter we've achieved a year-over-year improvement. This improvement reflects our continued confidence and commitment to drive margin expansion over the longer-term.

Turning now to SG&A, SG&A of $582 million increased 8%; 2 points of growth is related to the expensing of stock options and the remainder of the growth is primarily related to higher benefit cost and increased spending for new marketing programs and product launches.

R&D spending, on the other hand, of $146 million increased 10% with spending accelerating in each of our businesses. One area to highlight is our growth in BioScience R&D which exceeded 15% in the quarter. As a result of gross margin expansion our adjusted operating margin of 19% improved 1.8 points compared to last year -- the largest year-over-year improvement in over four years reflecting our continued focus on driving profitable and sustainable growth with operational discipline.

The 19% margin in Q2 is after absorbing $15 million for stock option expense. Excluding the stock option expense, our adjusted operating margin would have been 19.6%. To summarize, net earnings increased 21% for the second quarter with adjusted earnings per diluted share of $0.57, up 16% over last year after $0.02 for stock option expense. On an adjusted basis, excluding stock option expense, fully diluted EPS of $0.59 was up over 20% compared to last year.

Turning now to cash flow, we had another strong quarter given our continued focus on improving working capital. Cash flow from operations for the first six months totaled $848 million or a $70 million improvement compared to $778 million last year. Both DSO and inventory turns improved sequentially from Q1 driven by continued improvement in our international receivable collections and improved inventory performance in renal and BioScience. Net debt this year has been reduced by approximately $1.8 million compared to last year and we ended the quarter with a reported net debt to capital ratio of 18%.

In the second quarter we also purchased approximately 220 million of common stock. Through the first half of the year we have now repurchased 392 million of stock or approximately 10 million shares. Given our first half cash flow generation we are very well positioned with respect to our cash flow objectives for the year. We remain confident that our improved capital allocation disciplines will continue to drive sustainable improvements in cash flow and return on invested capital. As we balance our investments that enhance the longer-term growth we'll remain committed to return value to our shareholders using a disciplined capital allocation framework.

Finally, let me conclude my comments this morning by providing our outlook for the full year 2006 and the third quarter. Given our strong financial results to date with strong underlying fundamentals and momentum continuing across many areas of the Company, we've raised guidance for the full year. First, we expect organic sales growth in the second half of the year to accelerate and to grow in mid single to high single-digits. This will result in organic sales growth for the full year of approximately 6%. This is before the impact of foreign exchange which, at current rates, will be neutral or the full year.

Second, we now expect earnings per diluted share of $2.13 to $2.17 before special items. This is after absorbing approximately $0.08 related to stock option expense. Excluding stock option expense our guidance is $2.21 to $2.25 per share. This compares favorably to our previous full-year guidance of $2.10 to $2.16 per share. Lastly, given the increase in our earnings guidance, we now expect cash flow from continuing operations to approach $2 billion with free cash flow in excess of $1.4 billion.

In terms of gross and operating margins excluding special charges, we expect gross and operating margins to accelerate in the second half of the year compared to the first half. For the full year we now expect our gross margin ratio to improve by more than 150 basis points to the 45% to 45.5% range. As we have previously mentioned, the significant progress we've made in improving our balance sheet, earnings and cash flow provides us with considerable flexibility not only to deliver growth in the near-term, but to selectively invest in marketing activities and accelerate our investment in R&D to drive future value for our shareholders.

We now expect R&D to increase in the low to midteens for the full year. As we make increased investments in our recombinant, biosurgery and drug delivery businesses and in spending related to our Phase II adult stem cell trial for patients with chronic myocardial ischemia, a severe form of coronary artery disease. Overall we continue to expect our adjusted operating margin for the full year to reflect a year-over-year improvement of over 100 basis points. This is before absorbing the $0.08 impact of stock option expense I mentioned earlier.

Including stock option expense we expect operating margin to improve by approximately 50 basis points from last year's full-year operating margin of 17.3%. We continued to expect interest expense year-over-year to be reduced and to total approximately $50 million for the year with diluted shares averaging 650 to 655 million for the full year. As I previously mentioned, our EPS guidance for the full year as a result is $2.13 to $2.17 before special items and including the stock option expense.

For the third quarter we expect organic sales to grow 6 to 7% and, based on current rates, we expect currency to benefit sales growth by approximately 1 point. We also expect earnings per share to total $0.55 to $0.57 before special items. This includes stock option expense of approximately $0.03 for the quarter. Now let me turn the call back over to Bob for his closing comments.

Thanks, Rob. Just a few closing thoughts. In previous discussions with all of you I've characterized or I suppose categorized the turnaround at Baxter into two distinct phases. I think Phase I is largely now behind us and we've completed the restructuring program that was initiated almost three years ago now. We've also dealt with, as you know, a series of issues that affected our balance sheet including foreign asset hedge liability, our underfunded U.S. pension position and a number of other things.

We've rebuilt the senior management team, the team that will lead Baxter in the coming years, and we've also significantly improved our financial performance, which has clearly resulted in the strengthening of our overall financial position. As we now move into what I call Phase II of our turnaround, we are increasingly focusing our time, our attention and certainly our resources on ways to accelerate topline growth. And there are a number of new product and new business development initiatives that we've been funding that, frankly, we've not discussed with you in any great detail. These programs are the result of our internal strategic planning activities and our more focused R&D efforts over the past one to two years.

So as part of our ongoing efforts to communicate proactively with our investor base, at this point I'd like to announce that we will be holding an investor conference in Chicago on Wednesday, March 14, 2007. Much of the focus at the conference will be to provide visibility into our new product pipeline in ways in which we believe we can favorably affect topline growth in the years ahead. And Mary Kay and her team will communicate more of the specifics of the conference with all of you shortly. So I wanted to communicate that on the call this morning.

So with that, at this point I think we're ready to open up the call for questions that you might have.

(OPERATOR INSTRUCTIONS). Larry Keusch, Goldman Sachs.

Good morning. A couple questions. Bob, in your opening comments you talked a little bit about some of the developments with the FDA and COLLEAGUE. Can you just talk a little bit about -- I think I missed this -- what you need to change in that 510(k) -- I think you said to be consistent with CAPA and what other things specifically do you need to do now that may be different from the conference call on June 26th?

Well, as you know, we submitted a 510(k) sometime in the past, actually in advance of the finalization of the consent decree, Larry. Okay? And with the recent corrective action plan which we submitted, which I will tell you is an extremely comprehensive program. In fact, there was about 20 binders I think that got submitted to the FDA, and it includes an array of dimensions including technical design-related issues in terms of a number of the product improvements and product fixes, but it also is expensive to include all the logistical aspects that are involved and associated with the remediation efforts, including inventory of product and the like.

We have had, as I mentioned in my prepared comments, I think really constructive dialogue with the agency over the last couple weeks. And I think since the consent decree got signed in many ways that was an important milestone. Because I think, as I said in my call three weeks ago -- or in the call three weeks ago, it really had the agency and Baxter now aligned and pointed in the same direction and I think that's been reflected in the quality of the meetings and the dialogue that we've had with the agency since then.

But as part of that and as part of getting alignment on a number of issues, some of which affect the 510(k) as a result of pulling together and submitting the corrective action plan, we need to go back now and modify certain aspects of the 510(k) to make sure the 510(k) is totally consistent and aligned with what we are submitting as part of the corrective action plan.

Not to complicate things too much, but as I commented three weeks ago, there are really three concurrent pathways here to get the product back on the market. One is the traditional regulatory pathway of receiving a 510(k) approval. The second of course is filling the terms and obligations of the consent decree which are going to be required before we can commercialize the product. And the third is to get alignment with the agency, and this is much of what the corrective action plan is about, to move forward as quickly as possible with remediation.

All three of those have different timelines. It's my view at this point that the 510(k) approval frankly is not on the critical path. I think we'll work through that perhaps before we deal with some of the other issues. And candidly, there continues to be and will continue to be for some period of time some ambiguity in that regard which is why I was very forthright I think on the call three weeks ago that said don't plan on us recommercializing the product in 2006.

So much of this is about making sure our regulatory submission, our 510(k) is modified appropriately so that it is aligned in all respects with the corrective action plan which is really a different and much more comprehensive document. It's getting caught up on everything so they're aligned simply stated, Larry.

Okay. And just one follow up and just one other question quickly. So does that put the 510(k) behind in your initial thinking?

Not necessarily. Not necessarily. I'm not sure that we had a definitive date in terms of our initial thinking, okay? And given the seizure activity last year and given the full understanding on our part that the consent decree as an outcome was a possible outcome. We always knew candidly that that was more of a front burner issue than the 510(k). So I'm not trying to diminish the importance of the 510(k), I'm trying to put it in a context though, and I realize it's a little bit involved.

But, simply stated, as I look at those three pathways that had to be fulfilled, I think it's fairly -- clearly we can assume at this point we're not going to get to the end of all of those pathways by the end of this year which is why we took the position we did. Okay?

Okay. And then one sort of philosophical question for you. Now that you've seen your operating margin continue to expand, your free cash flow and operating cash flows continue to get better, etc., how are you thinking about, again, your appetite for acquisitions? And the other thing I'm thinking about is you really haven't done anything with the dividend in many years and certainly your cash flows would suggest you could do something there. I know that comes up in November, but maybe just give some thoughts on how you think about deploying these cash assets over the next couple years?

Our position on acquisitions hasn't changed; I think we've been very clear cut on that. We're open-minded to the right kinds of acquisitions. I previously characterized them as being opportunistic, bolt-on kinds of things in nature, that's another way of saying don't expect some big bodacious acquisition, we don't see that -- we don't see that in the offing, frankly. And so, I think our position continues to be that despite our improving financial condition on one hand, on the other hand our strategic approach to acquisitions has not modified from what it's been from the start.

We feel that there's enough opportunity for us to accelerate topline growth of which -- again, we'll provide more visibility at the conference in March that I announced in my comments -- that's where we want to focus our efforts. It doesn't mean, as I say, we're not open-minded to certain kinds of acquisitions, but they're going to be of the ilk that I described. Rob, I'll at you address the dividend thing.

It is a good question, Larry. And as you know, in the prepared comments I provided I did reference the fact that, given the strength of the cash flow we've seen now and now with the free cash flow guidance expected to exceed $1.4 billion, obviously it gives us the flexibility to revisit the dividend, which we will do in November, and make a decision at that time.

But I think it's safe to say whether it's the dividend or, as you know, the share repurchase, which we've, as I commented, repurchase nearly $400 million through the first half of the year and expect to continue on pace pretty similar to where we were in the first half of the year into the second half of the year, we are committed to returning cash to our investors as well as investing in the business. And frankly, given the strength of our cash flow, we're in a great position to be able to do both. So it's a good question, more to come and we will be looking at that this November.

Great. Thanks very much, guys.

(OPERATOR INSTRUCTIONS). Rick Wise, Bear Stearns.

Good morning, Bob. Thanks for a terrific quarter. A couple things maybe on the BioScience side. Can you talk about how much -- or what the contribution of improved pricing was to the BioScience out performance? And is this level sustainable? And maybe go on, if you could, to flesh out any thoughts about your capacity, ability to meet demand, industry capacity -- where are we and where we'd like to go (multiple speakers) two months?

Okay, a lot of pieces to that. As Rob commented, obviously improved pricing most notably in IVIG did contribute to some of the margin improvement. I don't think specifically we quantified how much nor are we going to do that necessarily. The next question is on sustainability, candidly I think this is sustainable for perhaps a long period of time actually, which really gets to the third part of your question which is the capacity in the industry and so on.

We don't have total visibility into that. We know that there's some amount of excess capacity in the industry, excess capacity in fractionation. Obviously what we're doing is we are expanding the amount of plasma that we collect and fractionate commensurate with what we believe the overall market is growing for plasma proteins, which at this stage in aggregate is probably mid to high single-digits; obviously it's somewhat higher on an IVIG right now.

So we think that in the marketplace today there's a reasonable balance or equilibrium in the industry. In supply and demand there is some rationalization and inefficiencies I think that have been and are being wrung out because of various distribution modalities and so on and that's getting I think cleared up. But we think that there's a good balance right now and our plan is to expand our production commensurate with what we see the market growing. And our view of our major competitors is they're probably doing the same thing.

The higher level question of capacity long-term and fractionation, we know there's some excess capacity and fractionation for the industry, including ourselves. It's not excessive, frankly, and given the way the market is growing right now, I think in the next two to three years whatever excess fractionation capacity exists today is largely going to be consumed.

And of course the lead-time to build new fractionation capacity and we're in a good position to address this given our own new L.A. frac facility and so on, is a fairly long lead-time. Whether it's expansion of existing capacity, could be as much as three years, or grassroots capacity as much as five years. So given all those things, Rick, we see continued stability for the foreseeable future, frankly.

Just two quick follow ups on that. The Alzheimer's use for IVIG, could that be a significant deal? How optimistic are you about that? And last, you both were highlighting the continued steady margin improvement. At this point what do you think are realistic either gross margin or operating margin goals looking over the next two to three years for Baxter?

Let me start the second question first. From day one we've said this is a business that ought to be able to generate 20% pretax operating profits; we've been less specific in terms of the time frame. I think it's interesting, and Rob pointed this out in his comments, with the adjustment for the stock option expense our pretax operating profit as a percent to sales in Q2 was 19.6. I think it's fair to say we're going to get to the 20% probably sooner than what various folks estimated going back a couple years ago when we highlighted this 20% objective.

And again, we think that's doable -- certainly doable with the businesses that we're in today. And we think, as I pointed out in my comments, there continues to be latitude for improving both gross and operating margins kind of the old-fashioned way, doing what we're doing, grinding it out, looking at pricing, manufacturing efficiencies, product mix upgrades and the like, okay? So we continue to be very optimistic for further margin improvements. I'm not going to be specific at this stage -- is their potential and if so how much beyond the 20%? Let's get there first and then we can talk about that.

The Alzheimer's thing, I'm sure everybody has followed some of the releases that came out of the international meeting in Madrid earlier this week, specifically the Cornell study which is now in Phase II. I mean candidly it's very, very exciting. It's also very, very early. So you know how these things go. I don't want to speculate on where it's going, but obviously that's an opportunity that candidly is really not dialed into our numbers and our outlook. But that's the kind of thing that we'll provide you maybe more insight and discussion in our March get-together.

Thanks a lot.

Glenn Reicin, Morgan Stanley.

Let me put you in an uncomfortable position here and discuss pricing for a second.

Discuss what, Glenn?

I'm sorry?

Discuss what did you say?

Pricing.

Pricing. Okay.

Between 2002 and 2004 I think you quantified that you lost roughly $200 million of pretax profits from negative pricing on the plasma business. How much of that do you think you've recovered?

Candidly I don't know. Obviously we've recovered a lot of it. I think there's still more to recover. But I've got to tell you, Glenn, looking at it that way I don't think that I've ever asked that question in that approach. So I really can't answer it, but I mean we've recovered a lot of it clearly. If you look at, as an example, IVIG pricing in the market right now, it's, as you know, gone beyond $50 a gram which is approaching levels that it was previously before the decline. So that metric alone would indicate that we've recovered much of it. But as you also know, Medicare approved an increase a couple weeks ago and there continues to be pricing latitude going forward. So beyond that I really can't be more specific. Not that I won't be, I can't be because I don't know.

Okay, just a couple more questions. What was unit growth for the Company in the quarter?

Unit growth for the Company -- that's another tough question. If you add all the units like IVIG grams and IV solutions and CAPD bags -- I don't even know how to define unit. You're talking volume growth?

Volume as opposed to price.

Rob, I don't know specifically.

We don't disclose specifically price volume mix, but I think -- and this goes to the question that was asked earlier as well -- the growth we saw through the quarter was a combination of both. So we are seeing volume increases in the market, as Bob mentioned, if you look at IVIG for example, that market is growing long-term. We think it's 6 to 7% range. It's frankly been growing probably even a little faster than that here through the second quarter. So we've benefited both from volume and price and continue to see benefits from both going forward.

And then you took out the one time items for the quarter -- for the first half and you said roughly you benefited net of around $160 million. What was it for the quarter?

I can get that for you, Glenn.

Probably a little less than half of that probably would be my guess. But we can get it for you.

Okay. That's the same as the 6% number or are we talking different definition?

No, the 6%, Glenn, was just excluding COLLEAGUE.

It's organic growth excluding COLLEAGUE.

The three big items that really made up the $260 million gross number we referred to was Propofol, COLLEAGUE and the net of Rocephin and Ceftriaxone. So really, those are the three big pieces that are driving us. If you looked at COLLEAGUE in the quarter, as I mentioned (multiple speakers) around $45 million. I think Propofol was in that same range of decline. And then if we look at Rocephin that is about 17. So you're looking at about 90 -- about 100 million of the 260 gross and then the ARC for the quarter backed off about another 55 million. So that's the quarter split of that.

Okay. And then can you give us an update on how the sevo launch is going? A lot of crosscurrents here; I thought for sure the number would not look strong given the comments from Abbott yesterday, but just looking at your anesthesia numbers it looks like they were strong -- a little bit more domestically than internationally which is a little bit counterintuitive because you launched earlier internationally?

I don't think we're going to be able to give you a lot of specifics on that. You know the markets that we've launched in; we've identified additional markets we're going to launch between now and the end of the year. We really don't want to comment specifically where those are for obvious reasons. So just for competitive reasons I really don't want to get into a lot of specifics on sevo, Glenn.

Are you fully launched in the United States right now?

Yes.

How long have you been there?

A very short period of time fully launched.

Glenn, we introduced the product in April on a full-launch basis. We had some sales in the first quarter but they were very small.

I think the important point, Glenn, is that as we put together our plan for launches beginning last year and into this year with the U.S., we're very much on track with what we expected. We feel good about where we are with volume and price. So from our perspective things are going well. Obviously for competitive reasons we don't want to give details, but there's been no concerns there at all; in fact, we feel very good about it.

And what were Suprane sales up in the quarter?

Suprane was --.

Suprane grew very nicely internationally, Glenn. It was up 30; it wasn't up as strong here in the states. We had a very strong Q2 last year with Suprane, but we're still projecting Suprane growth to be in the midteens for the full year globally.

Okay. All right, and Propofol is down 50%?

Right.

Got it. Thank you.

Mike Weinstein, JPMorgan.

Just a couple follow-ups. You had some issues with supply of albumen during the quarter. Did that drag your out performance at all?

A bit. I can't really quantify it for you, but yes, as you know, we've had some manufacturing difficulties which I think largely we've managed through now. But yes, it had a slightly depressing impact for the quarter.

Okay. Then as we think about the back half of the year for the medication delivery business -- which is obviously going to have a big swing with the easier comps -- outside the easier comparisons on the products you mentioned, is there anything else going on that we should be thinking about that is ramping more fundamentally, organically within drug delivery or the other businesses?

Well, we talked about anesthesia, the bits and pieces of that. The basic IV fluid systems business is actually very steady. As Rob pointed out, the disposable set piece, despite the COLLEAGUE issues in the U.S., was up 2% which is pretty much in line with market growth. We are launching at the end of the year the generic Zofran product, but that's late in the year so that's not going to have that big of an impact.

So Ceftriaxone continues to do very well in both the vial and the pre mix form, so that is going to be helpful on the year-to-year comps. And then of course the opportunity as we move into 2007 and beyond is deals we site up to take advantage of the capacity expansion at Bloomington, Mike. But again, there's not that much that's dialed in our guidance between -- incrementally year-to-year between now and the end of 2006. So those are really the pieces -- I don't think, Rob or Mary Kay, is anything else that jumps out that I've missed?

No, infusion systems, Mike, will turn around because we'll anniversary COLLEAGUE. Drug delivery will accelerate because of the added capacity and how we'll benefit in Bloomington from that capacity. And then anesthesia when we anniversary Propofol, sales will ramp up and accelerate due to sevo and Suprane.

How do you want us to think about the vaccine business, including the influenza opportunity and the actual broader vero-cell opportunity as well? How should we think about that business?

We think there's opportunities there throughout the business. Obviously, the most -- you addressed it. The most significant opportunity which is tough for us to quantify at this point could be the pandemic vaccine, as well as the seasonal flu vaccine, if the outcome of our trials are successful.

And we're going to know the answer to that certainly before the end of the year, and we continue to have dialogue with a number of governments around the world to fashion agreements not unlike what we did in the UK. And this is a bit of a wildcard that is really difficult to quantify as we sit here today. And as you all know, it is all a function of the outcome of the clinical trials which we don't want to speculate until the clinical trials are complete, but it is a wildcard is all I can say.

I would just add that as you think about that, one thing to dial in, especially as you think about the pandemic versus just the seasonal influenza, obviously it is going to come in boluses into our sales line as we get these contracts. So from a ratable growth perspective, it is going to probably make some comps difficult. But obviously, we will take it if we can get it, but just see that in mind as you think about that in your numbers.

Bob, last question. As we think about the transition to Phase II of trying to drive higher growth of the company, where should we be focused at this point in terms of opportunities to maybe bring in additional products or platforms?

Actually, all of our businesses. We remain highly committed to the diversified healthcare model. Clearly BioScience has been and will continue to be for the foreseeable future a star performer. But I will tell you I am very encouraged as evidenced by my comments and Rob's comments, the momentum that is starting to build within our renal business, specifically in the PD side for the reasons that we have mentioned, and now that the comparisons are a little easier for reasons we have already discussed on med delivery.

I am encouraged about the momentum in all three of our core businesses going forward. And when we get together in March at the conference, it is going to be more than a BioScience update on pipeline. There are things that we will talk about in both renal and med delivery that we are very enthusiastic about. So stating the obvious, the significant strength in BioScience over the last year or so has enabled us to manage through a lot of the issues, but I think encouragingly looking forward to be hitting on all cylinders here with all of our businesses.

A point that Rob made that I think is important doesn't go unnoticed is that on a year-to-year basis, we have had margin improvements in every one of our businesses in every one of our regions around the world. So the diversity of the portfolio both by business and geographically is really, really critical, and I think it provides certainly sustainability and sustainability of improvement going forward.

Operator?

Glenn Novarro, Banc of America.

Good morning. Two questions. One, you mentioned that there was a little stocking on Advate because of the high dose launch. Just wondering if you can quantify that, if it was material in the quarter. And then second, your antibody revenue doubled in the quarter. You mentioned it was due to -- some of it was due to the Red Cross. I am wondering what your organic growth would be ex the Red Cross contract, and what is a good way to think about growth of that business ex Red Cross going forward? Thanks.

To your first question, the high potency Advate, the initial stocking we referred to was in the 7 million range for the quarter. So a sizable number, but not a huge number. The ARC growth, I don't know, Mary Kay, if you have that top of your head. I frankly don't have it.

We talked about it adding $100 million of sales in the first half, and in effect the antibody therapy line and the plasma protein line in terms of sales year-over-year.

Should we assume a similar contribution in the second half?

No, I misunderstood your question. No, the $100 million is going to be in the 20 to $40 million range in the second half. That is -- to the point we tried to make, I think people focused on the anniversarying out of COLLEAGUE Propofol and the Rocephin out of the first half, which was a drag. But we actually will see the ARC be a drag in the second half of the year.

Now, that being said the net of all of these is still going to be percentage point or two of acceleration due to those anniversaries, but the ARC will definitely mute that in the second half of the year. That is why I was trying to point out that the $100 million netted into the 260.

Thanks for the clarification. So for antibody revenues, what would be the organic growth of that business going forward?

Difficult to get to, Glenn, with all of the dynamics, including ARC, the pricing improvements, the conversion to liquid.

I think the underlying market volume growth is probably mid to high single digits right now, and we would anticipate that continuing.

Okay, great. That is helpful. Thanks, guys.

Dhulsini de Zoysa, Cowen.

Bob, I know -- Rob, maybe this is for you. A couple of years ago when you set 20% operating margin as your goal, it seemed maybe a stretch. Today as you look out a couple of years without putting specific timeline on it, 22%, 24%, are those within your sights?

You are baiting me here. As I said in response to one of the earlier questions, we're going to hit the 20. We are going to hit the 20 probably sooner than we envisioned a couple of years ago. Is there upside beyond the 20? We certainly would hope so, but let's get to the 20 first and foremost, and then assess how much opportunity there is above that. But I really don't want to get pinned to a number at this point.

Okay, that's fair. Is it safe to assume that manufacturing will be the bigger contributor -- manufacturing may be mixed rather than pricing?

Look, the manufacturing piece we don't talk a lot about. Last year and into this year, clearly given the roll of medical plastics in so many of our products that are petroleum-based -- I mean, we've gotten killed by oil prices and so on. But the efficiencies that we've continued to realize within virtually all of our manufacturing operations -- BioScience, renal and MD -- have more than offset that. And I think strong manufacturing performance has always been a hallmark of Baxter throughout the years and we're going to continue to count on manufacturing efficiencies going forward. Rob, I don't know if you have anything to add to that?

No. Clearly, to your question, yes, gross margin improvements, both due to product mix shifts -- we're going to continue to see Advate conversion which is a favorable liquid IVIG, several products that will contribute positive mix. There are continued yield improvements. Obviously when we get our L.A. fractionization up and running that will bring benefits across other areas of our business. As well we're seeing yield and cost benefits.

So it's really a combination of both price, mix and yield and cost improvements that's going to drive it. Because obviously the other thing we are committed to do, and I think we tried to really stress it in the call, we're not going to get operating margin improvements by trying to sacrifice R&D for example. In fact, I think the strength of our gross margin is allowing us to do really significant increases in R&D investment and we expect that to continue going forward as we reinvigorate innovation across the Company.

So it is a gross margin story and really will fund for us good growth to allow us to protect the long term of the Company through innovation.

Rob, to pick up on your comment on Advate and the mix shift, where do you expect the ultra high dose to end up ultimately as a percentage of mix of recombinant product?

It's always going to be low, Dhulsini. It's a specialty product really; it's going to stay fairly low.

Yes.

So 10, 15%, is that (multiple speakers)?

That or less.

Okay, and then just one more -- administrative. You said sometime ago, maybe last summer, that you were in the process of reviewing your hardware and going sort of line by line. Where are you in that effort? Is that pretty much complete?

We've made great progress. I mean, when you say hardware you mean instrumentation really, like COLLEAGUE and other devices?

Right.

Well, we've made great progress. We made the decision to get out of production of hemodialysis machines, so we've intensified our focus. We've made great strides in development on our renal side specifically with HomeChoice which is the leading cycler for automated peritoneal dialysis in the market. It's a great product, but we're working on next generation follow-on products. These are some of the things we'll talk about in March. So I feel very good about the progress we've made there.

We also -- in the short-term we've consolidated our focus in med delivery really on COLLEAGUE and one or two other devices. We pulled a product off the market last year, the [60-60]. But where we're at now is organizationally -- I've commented on this previously -- we collapsed all of our engineering and R&D on instrumentation which historically or previously was decentralized in each of really three businesses -- renal, med delivery and the transfusion therapy part of BioScience -- and we created a center of excellence.

And actually we brought someone in from the outside, Bob Armstrong, to head that up so that all of our engineering and technical resources toward instrumentation are consolidated. And I couldn't be more pleased with the progress that we're making there. Obviously the focus has been and continues to be on doing what we need to do to address the COLLEAGUE situation, but it's an area where I believe strongly our competencies have improved significantly even just in the last 12 months. So I'm very pleased with the progress we've made there.

So Bob, am I hearing this correctly, that you consider that an ongoing process? Or will there come a point when you say okay, we've reviewed everything and we are at --

(multiple speakers) all of our instruments. Yes, we put product improvement programs in place sometime back for all of our instruments. And largely we've completed that on virtually all of our instruments. So I think what I'll call the catch up piece of this, in other words to kind of get current, that's behind us for all intents and purposes right now. Now the focus beyond COLLEAGUE is next generation instrumentation in all of our businesses.

Okay, great. Thanks very much.

Operator, we have time for one more question.

Matthew Dodds, Citigroup.

For plasma collections, Bob, one of the things that seems to be a bottleneck in the area is the amount of plasma collection out there. And you said you're still able to grow that along with market rate. Is the reason there because some of the original plasma collection companies that were bought a while back, those contracts are still rolling off and you're getting more plasma coming to you or are you actually able to expand the (multiple speakers)?

We're able to expand collection within the existing facilities that we own that obviously are the more efficient facilities. The ones that we sold off were less efficient and other issues associated with them and so on. So no, we have capacity to expand collections within the installed base of facilities that we operate today.

So for you in particular, you don't see any issue of a bottleneck in the collection side? You're going to grow --?

No, there's not a bottleneck on the collection side and I've commented on the capacity situation downstream in fractionation. The obvious issue here is collecting plasma and processing it to finished product is a long lead-time deal, it's six months plus. And so, given the manufacturing process associated with plasma proteins, to have any demonstrable change in output is obviously like turning a light switch on and off.

But we have capabilities at both the front-end collection, downstream with fractionation and, given the strength in the market, we're expanding both collection and output downstream commensurate with what we believe the market growth is to make sure that that supply/demand equilibrium is maintained.

Okay. And then just one more on the plasma side. There's other products beside IVIG that I think are getting price. Are there any that aren't getting price? Is Plasma Factor VIII really the only one that's kind of holding price? Products like [Feva], albumen I assume are also getting nice price increases?

We're actually getting price in most all the proteins.

Okay. Thanks, Bob.

Thank you, Matt.

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