百特醫療 (BAX) 2014 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, Corporate Vice President, Investor Relations at Baxter International. Ms. Ladone, you may begin.

Thanks, Sam. Good morning, everyone, and welcome to our Q2 2014 earnings conference call. Joining me today are Bob Parkinson, CEO and Chairman of Baxter International; Ludwig Hantson, President, BioScience; and Bob Hombach, Chief Financial Officer.

Before we get started, let me remind you that this presentation, including comments regarding our financial outlook, new product developments and regulatory matters, 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 detail concerning factors that could cause actual results to differ materially.

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

Thanks, Mary Kay. Good morning. Thank you for calling in. As you all saw in the press release issued earlier this morning, Baxter reported strong financial results for the second quarter, which exceeded expectations, and we've confirmed our full-year 2014 outlook. Adjusted earnings increased 5%, to $1.26 per diluted share, and worldwide sales advanced 16%. Excluding Gambro and foreign currency, Baxter's sales rose 5%, driven by solid growth across our global franchises.

Positive momentum continues to build, and Baxter's off to a strong start in 2014. We are driving solid performance across our entire business portfolio and advancing care in both developed and emerging markets. This provides a strong foundation to build upon, as we improve our competitive position, enhance operational, commercial and scientific effectiveness, continued to meet challenges posed by the global marketplace and regulatory environment, and create value for patients, healthcare providers and other key stakeholders. I continue to be confident in our prospects for the long term and believe we are well-positioned for sustained performance and success.

Our strong results reflect our strategic focus on improving access to care, as we broaden our global presence and advance the new product pipeline through both internal development and collaborations. During the quarter, we announced an array of pipeline achievements and approvals, advanced R&D collaborations with our partners, and made progress toward the separation into two leading healthcare companies.

First, within the BioScience business, we continue to build upon our global leadership position in hemophilia, as evidenced by a number of recent achievements, including European regulatory approval of a new manufacturing facility in Singapore for the production of recombinant proteins, including ADVATE and BAX 855, upon regulatory approval.

Baxter was granted multi-year awards for ADVATE in the UK and in Australia, where ADVATE was named the preferred recombinant factor A treatment. Baxter recently received regulatory approvals for ADVATE in Turkey and Russia, supporting efforts to increase access to recombinant treatments in emerging markets. With these approvals, ADVATE is now approved in 62 countries worldwide.

In addition, the FDA granted approval for the BAXJECT III reconstitution system, which reduces the number of steps in the reconstitution process for patients and caregivers. And we recently received European approval for myPKFiT, which is a new web-based individualized dosing device for prophylactic treatment. This device allows physicians to calculate personalized ADVATE treatment regimens based on patient information and individual pharmacokinetic profiles.

Lastly, we've now completed dosing for all patients in the Phase 3 clinical trial for BAX 855. To date, we have no reports of inhibitors or drug-related serious adverse events. We look forward to sharing the top line data in the third quarter, and continue to expect to file in the US before the end of year.

In addition to our internal R&D accomplishments, we're collaborating with partners on advancing R&D programs in new disease areas with high unmet medical needs which capitalize on our core technical capabilities, expertise and global channels. Progress to highlight includes first, initiation of two Phase 3 trials for an investigational etanercept biosimilar in rheumatoid arthritis and chronic plaque psoriasis by our partner Coherus Biociences. As you know, Baxter has obtained exclusive commercial rights for Europe, Canada, Brazil and certain other markets.

Second, the announcement by our partner CTI BioPharma on the completion of enrollment in its PERSIST-1 pivotal trial of pacritinib, a novel oral JACK2, Flit 3 inhibitor for patients with myelofibrosis, a chronic malignant bone marrow disorder. This is the first of two Phase 3 trials required to support regulatory approval. PERSIST-2 began earlier this year and is evaluating patients with low platelet counts for whom no viable treatment exists today. CTI and Baxter will jointly commercialize pacritinib in the US, and Baxter has been granted exclusive rights for all indications outside the US.

And finally, we continue to augment our portfolio with acquisitions like Chatham Therapeutics, which we announced last quarter, AesRx, which we announced just last week. AesRx is a private US biopharmaceutical company focusing on sickle cell disease with its development program Aes-103. This investigational oral prophylactic treatment is currently being evaluated in a Phase 2 clinical trial and has the potential to address an extremely high unmet clinical need in a community with inadequate treatment options and no recent major clinical advancements.

Moving on to Medical Products business, recent highlights include the presentation of data at a European renal conference supporting the safety and efficacy of the VIVIA hemodialysis system. As you know, the VIVIA system completed CE marking in Europe late last year and is currently being introduced on a limited basis in 2014.

In the US, we continue to engage in productive dialogue with the FDA regarding the design of our final clinical trial supporting a nocturnal indication, and we are working towards initiating this trial before the end of the year. In addition, Baxter received 510(k) clearance from the FDA for our next generation Sigma spectrum infusion pump, offering an option for wireless connectivity and integration of data into a hospital's electronic medical record.

Before I turn the call over to Bob to review our financial results and outlook for the remainder of the year, I'd like to take a moment to outline the progress we're making to create two separate independent global healthcare companies. First, as you know, we've named Bob Hombach Chief Financial Officer of the new biopharmaceutical company, and Jay Saccaro Chief Financial Officer of Baxter International, following completion of the transaction. I've had the pleasure of working directly with Bob and Jay for many years and I'm confident that both businesses are positioned for future success, given their deep knowledge of these businesses, financial expertise and their leadership qualities.

In addition, last week we announced the appointment of Dr. John Orloff as Vice President and Global Head of R&D for Baxter BioScience. Dr. Orloff will be responsible for advancing the late stage bioscience pipeline, enhancing the current R&D operating model, and pursuing additional innovative opportunities for the business. Dr. Orloff joins BioScience from Merck's Serono Pharmaceuticals, where he served as global head of clinical development.

We continue to work diligently to prepare the organization for the spinoff and expect to announce additional senior leadership appointments in the coming months. In addition, we are currently targeting the filing of a preliminary Form 10 with the SEC before the end of the year.

We're planning to host an investor conference in New York in the second quarter of 2015 to provide details on both companies, and we expect to finalize the transaction by mid-2015. As always, I'd be happy to address questions on this or any topic during the Q&A this morning. But with that, I'll now turn the call over to Bob.

Thanks, Bob, and good morning, everyone. As Bob mentioned, adjusted earnings per diluted share in the second quarter advanced 5%, to $1.26, which exceeded our previously issued guidance range of $1.18 to $1.22 per share. This over achievement can primarily be attributed to strong sales across several franchises, including cyclophosphamide in the absence of any new competition, and the favorable timing of a large [Fibra] shipment originally scheduled for the third quarter. These items each drove favorability versus our guidance of approximately $0.02 per diluted share, respectively.

As we mentioned in the press release, GAAP earnings of $0.95 per diluted share included net special items totaling $172 million, or $0.31 per diluted share, primarily for intangible amortization and costs associated with contingent revenue and product development milestone payments, remediation efforts related to the in progress Spectrum infusion pump recall, integration of the Company's acquisition of Gambro, and Baxter's planned separation into two independent healthcare companies. These charges were partially offset by the reversal of certain business optimization and litigation reserves.

Now let me briefly walk you through the P&L by line item, before turning the financial outlook for 2014. Starting with sales, worldwide sales of approximately $4.3 billion advanced 16% on both a reported and constant currency basis, driven by solid growth across our global franchises. This performance exceeded our sales growth guidance range of 12% to 13%. Excluding Gambro revenues of $408 million, Baxter's sales rose 5% on a constant currency basis.

In terms of individual business performance, Global BioScience sales exceeded $1.7 billion and advanced 7% in the second quarter. On a constant currency basis, sales increased 6%. Within the product categories, hemophilia sales of $904 million increased 6% on both a reported and constant currency basis.

We continue to capitalize on our global leadership position and brand differentiation. New product launches including the new Fibra prophylactic indication and Rixubis for the treatment of hemophilia B and increased penetration of recombinant therapies, particularly in emerging markets. Specifically, global demand for ADVATE remains very strong, resulting in double-digit growth for the quarter and year-to-date.

This reflects the positive patient experience with our brand and ongoing benefits derived from our prophylactic label expansion, augmented by shipments to Brazil as part of our ongoing collaboration with Hemobras to advance access to recombinant Factor VIII therapy. To date, we have converted more than 35% of the 10,000 hemophilia A patients in Brazil and continue to expect to generate sales of more than $100 million in 2014.

In addition, global demand for Fibra remains robust. We are benefiting from the new prophylactic indication in the US, where we generated double-digit growth this quarter, and we recently received approval in Canada, Australia and Japan. As you may recall, only 15% to 20% of inhibitor patients globally are treated prophylactically, presenting a significant long-term growth opportunity for our hemophilia franchise.

In BioTherapeutics, sales of $548 million increased 7% on a reported basis, and increased 6% on a constant currency basis. This reflects sequential improvement driven by enhanced product availability and growth of immunoglobulin therapies, albumin and alpha-1 treatments.

Consistent with last quarter, US sales increased 7%, while International sales were up 4%. International growth was marked by improved growth for immunoglobulin therapies and albumin, as we've resumed albumin shipments to China. While US growth may moderate in the second half of the year, due to tough comparisons, we expect International growth to accelerate on a sequential basis in the third and fourth quarters.

In BioSurgery, sales totaled $189 million and increased 6%. On a constant currency basis, sales rose 5%, driven by increased penetration for surgical sealants like Tiseal and Floseal, particularly outside the US. As you know, growth of these products is tied directly to growth in surgical procedures, which remains very modest.

Finally, vaccine revenues totaled $110 million and increased 12%. Sales grew 6% on a constant currency basis, driven primarily by strong sales of the FSME vaccine, which was partially offset by lower milestone payments related to government collaborations for the development of influenza vaccines.

In Medical Products, global sales of more than $2.5 billion increased 24% on both a reported and constant currency basis. Excluding Gambro, medical product sales grew 4% on a constant currency basis.

Within the product categories, Renal sales totaled $1 billion, which includes the contribution from Gambro of $408 million. Excluding Gambro, Renal sales of $636 million declined 3% or 1% on a constant currency basis, as expected. PD patient gains in the US have never been stronger, driving USPD growth up 15%. However, this was more than offset by lower International sales, which were impacted by the timing of certain tenders which we discussed last quarter, and the divestiture of the CRRT business. Excluding these items, which totaled approximately $40 million, global Renal sales increased approximately 4%.

Sales in the Fluid System category of $816 million increased 8% on a reported and constant currency basis. Performance continues to be driven by favorable demand and pricing for IV solutions and other injectables, particularly for cyclophosphamide. As you may know, to date we have not experienced any new competition for cyclo, and we've updated our full-year guidance to reflect our new assumption. On a year-to-date basis, US cyclophosphamide sales totaled approximately $225 million.

Specialty Pharmaceuticals, which includes our inhaled anesthetics and nutritional therapies, posted sales of $404 million, reflecting an increase of 10%. Sales rose 9% on a constant currency basis, driven primarily by increased penetration of Suprane in markets outside the US and high single digit growth of our global nutrition franchise.

Finally, sales in BioPharma Solutions, which is our pharma partnering business, totaled $249 million and declined 3% on a reported basis or 4% on a constant currency basis. Performance can be attributed primarily to the timing of shipments and lower third-party demand, which was partially offset by strong pharmacy compounding revenues.

Turning to the rest of the P&L, gross margin in the quarter was 50.7%, compared to 53.0% last year. Margin expansion in the base Baxter business resulting from mix benefits was more than offset by the impact of the lower margin Gambro business and foreign currency, which collectively reduced the rate by approximately 250 basis points.

SG&A totaled $961 million and increased 18%, with the Gambro acquisition accounting for the vast majority of the growth. Excluding Gambro, SG&A increased 4%, as leverage was derived from benefits associated with our business optimization initiatives. This was partially offset by select investments in promotional and marketing initiatives for new product launches and within International markets to enhance our global presence, and the incremental expedited freight charges to support the strong demand we are seeing in the US Medical Products business.

R&D spending in the quarter of $292 million increased 15% versus the prior year. Excluding Gambro, R&D spending rose 2%. We continue to advance the new product pipeline and accelerate investments in a number of areas, including programs in our leading hemophilia franchise, those leveraging our expertise in the therapeutic areas of hematology, oncology and immunology, and investments in renal therapies aimed at improving patient outcomes across the continuum of care.

The operating margin in the quarter of 21.3% is lower than last year's operating margin of 23.8%. Excluding Gambro, the operating margin was 23.5%, as positive mix was offset by foreign currency and investments in SG&A and R&D. Interest expense was $42 million in the second quarter, which reflect debt issuances to fund both the Gambro acquisition and the Covington plasma manufacturing site.

Other income totaled $17 million, driven primarily by the favorable foreign exchange impact on balance sheet positions. The tax rate was 21.8% for the quarter, in line with our expectations. And as previously mentioned, adjusted earnings per diluted share advanced 5%, to $1.26.

For the first half of 2014, cash flow from operations was strong and totaled approximately $1.2 billion, reflecting an improvement versus last year. DSO ended the quarter at 56.7 days, and excluding Gambro, Baxter's DSO was 53 days, slightly lower than the prior year. Inventory turns of 2.2 are comparable to the prior year period. And lastly, in the first half of the year, we repurchased approximately 6.4 million shares for $450 million, or on a net basis, 2 million shares for $218 million, in line with our full-year objective.

Finally, let me conclude my comments this morning by providing our financial outlook for the third quarter and full-year 2014. For the full year, we now expect adjusted earnings of $5.10 to $5.20 per diluted share. We continue to provide a wider guidance range than our historical practice, as a number of factors and assumptions impact the outlook in the second half of the year, particularly potential headwinds related to cyclophosphamide competition and foreign currency.

As mentioned earlier, we have updated our assumptions for cyclophosphamide competition. While this has resulted in a transitory benefit, it also provides the opportunity to accelerate investments that will better position both BioScience and the Medical Products businesses for sustained success going forward.

For the full year, the cyclo benefit is currently estimated to be more than $0.20 per diluted share. This benefit will largely be offset by incremental investments we are making across the portfolio, and by absorbing a foreign currency impact of almost $0.25 per diluted share in 2014, which is approximately $0.10 per share higher than our original expectations.

Specifically by line item of the P&L, starting with sales, we now expect sales growth, excluding the impact of foreign currency, of approximately 10% to 11%, which includes annual sales of more than $1.6 billion for Gambro. At current foreign exchange rates, we expect reported sales growth of approximately 9% to 10%. Excluding Gambro, we expect the base Baxter business to grow approximately 3% on a constant currency basis.

For the full year, we continue to expect gross margin for the Company to decline by approximately 150 basis points from the 2013 margin of 52%. Positive sales mix in the base Baxter business is more than offset by Gambro and the full-year foreign currency impact of approximately 100 basis points.

In terms of expenses, we continue to invest to support the elevated level of sales reflected in our guidance, as well as accelerated spending in sales and marketing to support new product launches and R&D investments primarily related to recent business development activity within BioScience, while making incremental investments in our Medical Products operations to enhance our operational effectiveness. As result, we now expect R&D and SG&A to grow in high single digits for the full year, representing an increase of approximately $200 million versus our original 2014 expectations. This includes an incremental impact from foreign currency of approximately $50 million.

We expect interest expense to total approximately $160 million, and we now expect other income of approximately $70 million for the full year, the vast majority of which has already been recognized in the first half of the year. We expect a tax rate of approximately 21.5%, and we expect a full-year average share count of approximately 547 million shares, which assumes approximately $300 million in net share repurchases.

From a cash flow perspective, we continue to expect to generate cash flow from operations of approximately $3.5 billion, which excludes the cash cost associated with the spinoff of the biopharmaceuticals business. We expect capital expenditures of approximately $1.8 billion, which includes Gambro and the investments we are making to enhance our plasma manufacturing footprint in Covington, Georgia.

Let me move to sales and expand in our assumptions for the two businesses and the major product categories. Beginning with Medical Products, on a constant currency basis, including the contribution of Gambro, we now expect sales growth of approximately 14% to 15%. Excluding Gambro, we expect sales for Medical Products to grow 1% to 2%. Specifically, we expect Renal sales to grow approximately 40%, including the benefit of continued PD penetration and the incremental revenue contribution from Gambro.

We now expect Fluid System sales to be flat to up 2%, reflecting a benefit of approximately $150 million relative to our original guidance. We are now assuming that we experience competition for cyclophosphamide later this year, reducing sales by approximately $50 million to $75 million compared to sales in the second half of 2013. We continue to expect Specially Pharmaceutical sales, which includes our nutritional therapies and inhaled anesthetics, to grow in the 3% to 5% range, and we expect our BioPharma Solution sales to be flat for the full year.

For BioScience, we are also raising our guidance and are now project sales growth, excluding foreign currency, of 4% to 5%. Our outlook includes sales growth in our global hemophilia franchise of 5% to 6%. While we continue to expect increased competition for recombinant Factor VIII therapies in the second half of this year, performance will be fueled by underlying global demand for ADVATE, conversion to recombinant therapy in Brazil, new tender awards, and continued benefits from new product launches, including rexubis and Fibra prophylaxis.

For the Bio Therapeutics franchise, we continue to expect growth of approximately 4%, with sales of immunoglobulin therapies and albumin in China ramping up in the second half of the year. And finally, for our BioSurgery and Vaccine businesses, we now expect growth in the low to mid-single digits.

As mentioned in our press release, for the third quarter, we expect earnings per diluted share, excluding special items, of $1.28 to $1.32. We expect sales growth, excluding the impact of foreign currency, of 12% to 13%. Excluding Gambro, we expect the base Baxter sales at constant currency rates to grow approximately 4% to 5%. Thanks, and now we'll open up the call for Q&A.

Thank you.

(Operator Instructions)

So that we may be respectful of everyone's time, please limit your comments to one question, with one follow-up question, if necessary. We appreciate everyone's patience and would like to provide as many of you as possible the opportunity to ask a question.

(Operator Instructions)

I would like to remind participants that this call is being recorded, and a digital replay will be available on Baxter International's website for 30 days, at www. baxter.com.

Derrick Sung, Sanford Bernstein.

Hello. Good morning. Thank you for taking my questions. And congratulations on a strong quarter. I wanted to get right to the key controversy surrounding the stock right now, which is the sustainability of your hemophilia franchise. You've raised hemophilia guidance for the back half of this year. At the same time, you are starting to see the competition now coming from the longer acting Factor VIIIs.

Just wondering if you could comment on is that hemophilia guidance raise coming from the confidence in the sustainability of your ADVATE franchise in the face of competition? Is it coming more from some of these other growth drivers that you mentioned? Just give us a little bit more color on how you are thinking about that business moving forward. Thank you.

Bob and Ludwig, do you want to respond to Derek's question?

Sure. Hello, Derek. This is Ludwig. So overall, we are very pleased with our hemophilia performance. As Bob was saying, we are increasing our sales guidance. I think the confidence is coming from different angles. First of all, we feel that ADVATE gold standard position is a strong position, and that we believe that we will be able to continue to grow our ADVATE position through different factors.

In addition to that, we have new products coming in. We have [Ruxubris]. In addition to that, the Fibar prophy indication is also a strong growth driver. In addition to that, we have geographical expansion playing a role. So overall, we feel good about the guidance that we gave you and we believe it's coming from different angles here.

Could you perhaps give us, quantify a little bit more for us, the opportunity from the recent OUS tender wins and the launches in Russia and Turkey of ADVATE, as well as maybe, Bob, if you could give us a sense for how much Brazil is contributing this quarter?

Sure, Derek. The tender wins in Australia and the UK, we'll really start ramping up activity here in the back half of 2014. So relative to our expectations, and we did have good line of sight on one of those two to begin with. So relative to our expectations, not much of an incremental contribution here in 2014. But as we move into 2015 and beyond, these are multi-year tender awards and I think position us to significantly increase our market share in the UK, where it had gotten down to below 10%, at one point here. And as you know, we were completely out of the Australian market and now we have the preferred position. So we've not specifically quantified that opportunity at this point; but for both of them, it will be a meaningful opportunity to grow internationally and a key franchise for us.

As a relates to Brazil, as mentioned before, we're going to experience some lumpiness here as we continue to ramp up conversion and continue to open up the opportunity for different segments within Brazil. And so again, we're projecting more than $100 million of sales here. The contribution in the second quarter was fairly modest. We do expect that to ramp up throughout the course of the back half of this year. So more than half of that $100 million is going to happen in the back half.

Maybe one final follow-up to Ludwig's comments. Ludwig, can you maybe give us a little bit more detail now that the Biogen longer acting is in the market, and that you've seen the label? Could you just maybe give us a little bit more detail on your expectations for the impact from that versus what you were thinking before, as you've seen the label? And any additional color on the early progress of their launch and how you're specifically detailing against that competition? Thank you.

Yes, Derek, I think that their label is not much differentiated from the ADVATE label. If you look at the ADVATE label, it has very strong annual bleed rate data in there, which is unsurpassed and which is still, from a patient perspective, the most important thing. We also have individualized PK in our label. We have every three day dosing in the label.

And when you look at the use of ADVATE, ADVATE prophy patients are on an every three day or longer dosing regimen already. And so the data that we've shared with all of you are survey data that comes from patients and healthcare providers tells us that yes, the interest of the community is there for a longer acting -- the definition of a longer acting for hemophilia A is once per week or longer dosing regimen.

So our expectation is the same as the guidance that we gave you. And that is, we expect a single-digit impact on our ADVATE market share, until 855 comes on board. Bob talked about the fact that we've completed the enrollment, we completed all the assessments. We're on track to share 855 data with you third quarter, and we are still on track for a submission by the end of this year.

Larry Keusch, Raymond James.

Yes. Hello. Good morning. For Bob Hombach, and then I have one for Bob Parkinson. Just again, I just want to make sure I'm understanding the cyclo updated guidance. So are you saying now that you obviously haven't seen any competition yet, and now you are thinking later in this year? And on top of that, I think you had been initially anticipating about a $0.25 impact. Are you now saying it's $0.20? Again, I just want to make sure I'm getting that all correct.

No. We're now expecting competition to enter late Q3 or to early Q4. We had previously guided to a potential negative impact of $0.20 to $0.30 that we baked into our initial guidance. And from that initial guidance, we are saying that's going to get a little bit more than $0.20 better. So we are going to have improvements relative to our expectations around cyclo, original expectations of a little more than $0.20.

Okay. And then you mentioned the investments that you're going to make against that. So how do we think about the net impact of all of this?

The net impact is, as you know, we didn't change our overall guidance. So I talked a little bit about a pretty significant ongoing currency headwind that we're incurring here of an incremental $0.10 to our expectation, as well. So that's largely half of it.

The rest of it relates to incremental investments that we're making. And as you know, we did a couple of business development deals here recently in gene therapy for hemophilia A, as well as an acquisition for sickle cell anemia treatment. Those are going to come with R&D burns with them, and so that is going to ramp up our R&D spend, that and a few other things, about $50 million for the rest of this year.

And then we're making incremental investments to support numerous new product launches, primarily in bioscience in SG&A, that really, those two make up the bulk of the difference between the $0.20 benefit from cyclo and the $0.10 downside related to FX.

Got you. And then, I guess for Bob and maybe for Ludwig. Obviously, post the Medtronic and Covidian deal, and some of these other ones that are getting announced, clearly scale is something that seems to be thematic out there. You guys obviously are going to initially get smaller with the spinoff, so I'm wondering if you could discuss a little bit about how you guys think in the individual businesses, the needs to get better -- to get bigger, and perhaps the strategy behind that?

Let me make some general comments for both business, and then more specifically regarding new BAX. And if Ludwig wants to comment on new Bio going forward. Stating the obvious, we're consumed right now with activities associated with the spin. So it's not about, at this stage, thinking about getting bigger, it's about really moving forward to execute effectively the spin. Of course, one of the strategic motivations behind the decision itself was to increase the focus in both businesses.

I can tell you from a new BAX perspective, if you will, we feel there are significant opportunities to grow earnings at a faster rate than sales, as result of a number of things. But one of which is, to your question, I think aggressively managing portfolio, whether that's business, product, geographic portfolio and so on. And I think you can anticipate post-spin activity in that regard. That also sets the stage then, I think, to be proactive in terms of BD acquisitions and so on, to reshape, if you will, the portfolio that comprises new Baxter going forward.

But again, those are things we're evaluating the right now, but not spending a lot of time on, given the focus of the energy areas is really on the spin. Ludwig, from a new Bio perspective, if you want to add anything to that, I think probably describes the tension of your organization right now, as well.

Correct. I think the question is not how do we get bigger here. I think the question is finding the right opportunity within the disease areas that we are focusing on, which is immunology and hematology, oncology. And I think the question now, can we make a difference in patients' lives and how can we bring value?

I think that's a great summary, in fact. I think you said it, it's not about getting bigger at this stage, it's about getting better. And the spin, at its heart, was really about intensifying the focus in each of the businesses, so that we can be better, both from an innovation point of view, as well as how we launch and commercialize our products and manage the portfolios in both businesses. So the question of getting bigger is something we always think about, but I would tell you right now, it's not really front burner, Larry.

David Lewis, Morgan Stanley.

Good morning. Bob Hombach, I just want to come back to the margins here for a second. And I understand the discretionary spending in the back half of year. But as it relates to the second quarter, were some of these discretionary spending items present in the second quarter, because obviously we would expect a little more upside here in the second quarter relative to expectations, given the very strong revenue?

And then Bob, some of the things you described are discretionary in nature in the back half of the year. How much of those carry forward into next year? Because some of the things you described are more baseline spending on some of the new JV initiatives, and some, I imagine, you can modulate pretty good heading into 2015. So can you give us a sense of whether these items are 2014 discretionary or linger into 2015? And then I have a quick follow-up.

Okay. As it relates to second quarter, there was a fairly significant impact to gross margins. We did see some incremental SG&A, not so much in R&D yet. As I mentioned, the two new acquisitions really are just going to start impacting BioScience and R&D run rate perspective in the second half of this year. But from a gross margin perspective, the impact was pretty significant in the second quarter, primarily from FX. And the driver there really is the Euro.

And as you know, as we've talked about in the past, given our global footprint, we have significant sales in Europe in the base Baxter business. Gambro had more than 50% of their sales in Western Europe, as well. So that actually increased our exposure on the sales line, which is a good thing. But on the cost side, historically we've been able to mute most of Euro fluctuations at the gross margin line through a combination of our manufacturing footprint and financial hedging that we do.

But as we've added Gambro into the mix, Gambro actually has a disproportionate amount of their manufacturing footprint in Europe, and so their cost relative to revenue was much higher in Europe. So in fact, the very strong Euro that we saw in the second quarter was a pretty meaningful negative to gross margin, because sales were higher related to the FX translation, but costs were even higher, and so that pretty meaningful gross margin impact, as we mentioned, between that and Gambro, a 250 basis point negative on gross margin. So the lack of drop during the second quarter more is related to gross margin, primarily FX, and less to do with these incremental investments, which again, are primarily back half.

And then as it relates to discretionary, clearly the R&D run rate for those two acquisitions is going to be there going forward. The SG&A in new product launches, though, certainly can be modulated. And that's what we're doing now. We do have a plethora of new products to position in the market over the next 6 to 12 months, and we're going to make sure we make the right investment there. But we do have a bit more flexibility on that.

Okay, helpful. Thanks, Bob. And then Bob Parkinson, as you think about the spin heading into next year, obviously one of the biggest drivers of the Medical Products business will still be Gambro in the broader Renal franchise. So maybe you can give us an update here, over the last six months.

Where do you think you stand as it relates to the organic growth profile you expected at Gambro, the capacity coming back online, and some of the cost opportunities that you saw. How would you give us a summation of where Gambro sits across some of those metrics? Thank you.

Yes, Dave. I would say, first of all, at a high level, we're tracking very well with the original expectations. More specifically, in terms of the cost synergies, again tracking just maybe a little bit behind in the short term, but longer term, we feel that the target we communicated to you is more than achievable, encouraging earlier returns, I think, on commercial synergies.

So when you look at the size of the business in terms of revenue, what's becoming increasingly evident is the way to really monitor this business is more broadly what we call Baxter Gambro Renal now, because we are seeing in the marketplace the expectation that the full complement of products would lever the legacy Baxter businesses, perineal dialysis and obviously home hemo, going forward. In fact, if you look at our total Renal business, revenue growth continues to perform very well. And so in that sense, in terms of the revenue line, we continue to be very optimistic that we will achieve, if not exceed, the original expectations.

Having said that, on the legacy Gambro business, we continue to focus on ramping up capacity, specifically in the dialyzer area, which is going to continue to be a challenge over the next year or two. Simply stated, there's more demand right now than our ability to deliver. You note some of the historical issues that the previous owners of Gambro were dealing with in that regard and so on.

But we're moving forward to expand capacity in our two primary dialyzer facilities in Hessigan, Germany and Opalika, Alabama. And it's just a matter of time before we get that capacity ramped up so that we can accelerate the growth of the dialyzer business. The acute business and the hospital is growing very nicely. And the monitor business, we are pleased with how the monitor business is performing, specifically some of the reliability improvements and so on. So without getting more granular, I would say, again, back where I started, at a high level, things are tracking very nicely with our expectations.

David Roman, Goldman Sachs.

Thank you. Good morning, everybody. I wanted to start with -- I think the announcement was -- it was yesterday, and you highlighted it today on the call -- the initiation of the Phase 3 trials in atenercept. Maybe you just talk a little bit more about what you see the US regulatory pathway being for your biosimilars program and how we should expect that to unfold over the next couple years?

Hello, David. It's Ludwig. I think it's, as you said, it's evolving. And I don't think everybody has the answers here. But for us, it's critical that this is an opportunity to create access to those molecules.

We are building a portfolio. We believe that a portfolio approach for us is critical. So we are building this portfolio. And at this moment, we have three molecules, one with Coherus and two with Momenta. I think there's an opportunity within the regulatory pathway to go for interchangeability. Of course, that's going to depend on finalizing those regulations, as well as what other product characteristics. But we believe that we are in a strong situation, at least with one of the approaches that we have, to shoot for interchangeability.

I think you've seen that some of those, at least one of the molecules is in Phase 3. The other molecules continue to advance in development. So stay tuned. We'll know more as we move forward here.

And David, specifically related to atenercept, remember we have OUS rights in Europe and several markets outside the US. So it's not a product that we will have rights for in the US.

Got it. Thank you. And then just a follow-up maybe to Bob Parkinson's comment, I think in response to one of the earlier questions about leverage in the business, and you did reference a potential for the remaining Baxter International to generate revenue growth and earnings with earnings growth pacing at a faster rate.

Could you talk about the opportunity set there? Because one of the things that stands out to us, at least when I look at your quarterly or annual filings, is the extent to which the current medical product margin sits below peers. And I assume we'll see more in the Form 10. But maybe you can preview for us some of the opportunities that exist there to close the gap in your Med Products margins versus peers that has the potential to drive outsized earnings growth for some period of time.

Sure, David. First of all, kind of at a high level, everybody focuses on the creation of the BioScience spinoff as a new public company. But I will tell you, our mindset is we're creating two new companies here. This spinoff of BioScience provides the legacy Baxter business which, as you know, I will run going forward, I think, an opportunity to reevaluate anything and everything that we do. And I think that's really healthy, and that's the mindset that we are embracing.

First of all, I think intensifying focus on higher margin growth areas, product categories like anesthesia, parenteral nutrition, certainly the BioSurgery business, which while we've developed that market very nicely in the US, continues to be very undeveloped in many markets outside the US.

Also in infusion pumps. With the approval of the SIGMA Spectrum a month or so ago and the anticipated launch later this year with that, it's going to put us in a position to play offense in infusion pumps for the first time, really, in many years. If you look at the margin accretion opportunity over the next five years or so in the infusion pump business, for us to regain the share that we lost over the years in the US due to the [Collig] situation and then be able to expand outside the US, there's probably $0.30, $0.35 of EPS equivalent associated with margin accretion opportunities just in the infusion pump area. So anesthesia, nutrition, infusion pump, BioSurgery, all higher-margin areas, will benefit from intensified focus. And as I mentioned, infusion pumps benefiting from now the ability to play offense with the recent approval.

I commented earlier then on the opportunities in terms of portfolio. And I think that there's significant opportunities to evaluate, as an example, core businesses like IVs. In certain markets, the IV business, where we can bundle with a contract that includes the disposable sets, the infusion pumps, the secondary, the mini bags, the pre mixes and so on, continues to be a very attractive business from a return on investment.

In certain markets where we're in IVs where we're contracting separately for IVs, these are largely international markets. I think we really need to be more aggressive, in terms of evaluating what is the sustainable value of these businesses. And so that's the kind of example, from a portfolio geographic, in that sense, the kind of things that I think we will be much more proactive in.

I also think, in terms of this new mindset, and I'm challenging the organization to evaluate really new paradigms in a lot of different areas. This recent IV shortage in the US, I think has sensitized a lot of people to the value of these products, products that largely have been taken for granted historically, which are essential to saving and sustaining lives, and I described it always as the best deal in health care. To be able to pay for a half a liter or liter IV a lower price than a bottle of water at 7-Eleven, that puts it in perspective. And I think there's opportunity there in terms of taking prices up, and really getting value commensurate with the value that those products serve clinically and so on.

So I'll stop there. I would just tell you, I'm very excited to really lead this new organization and I think focus on those areas for margin accretion that exist. So this will be a subject we'll talk a lot about in the coming months, and certainly post-spin as we crystallize more specifically. But there's fertile ground here, I believe, to support my earlier comment about being able to drive earnings growth at a much faster rate than revenue growth in this new business.

Mike Weinstein, JPMorgan.

Thank you for taking the questions. First one, Bob Hombach, when you had the late March call to announce the separation, it sounded like you still had a fair amount of work to do to put some numbers behind the separation costs. Have you had any additional work done on what you think the dilution from the spin will be, meaning really, for you guys will be all the incremental overhead that will have to be created. And I think you said at that time you didn't expect any tax leakage. So has there been any change there? Thanks.

No change on the view on tax leakage, as I mentioned. I think transactionally, as we create legal entities and move assets and people in various countries around the world, there may be small amounts, which we'll call it out as separate special items. But in terms of ongoing tax rate for the two businesses, no change in prior view, nothing significant we see for either business here at this stage.

As it relates to synergy, we're certainly working diligently internally to estimate what gross synergies are going to be and then how we're going to go about mitigating them, how much before the spin occurs and how we will be able to get out the cost position over the first year or two. Again, we're not seeing anything significant or different than what our consultants would say benchmarks look like. So nothing has popped up and no red flags from what I said before, that I think we are largely going to be in line with the type of operational synergy you've seen from other spinoffs.

I would say, though, that our International footprint, which represents 60% of our sales on an annual basis, we are very integrated, it will be very complicated to separate the two businesses. But I think as we create a new biopharmaceutical company in an international framework, we'll be able to do that in a fairly streamlined way. So again, there may be a little bit of extra dilution on day one related to International, but nothing significant.

Okay. And then can you give us an update on maybe -- well, maybe two items -- one, you haven't talked about recently the plans for the vaccine business. Has there been any progress there? And then two, we've got the [Iquvia] panel coming up at the end of the month, can you set expectations for what we'll see that will be new in the panel pack, and how you expect the language from the FDA to read in the panel pack? Thanks.

Bob, do you want to handle the vaccines, and then Ludwig can --

Certainly. As we mentioned earlier this year, we did take the strategic decision to look at first, a couple of the development programs within R&D, particularly flu and our Lyme program, and see if those would be better served to be partnered or divested. And we also were open potentially to our two in-line vaccines, to devesting those, as well, depending on the preference of the partner.

So we've gone through a process, talked to a lot of different interested parties. And that process is ongoing, so not appropriate to comment further now. We are very focused on optimizing the value of the overall vaccine portfolio; and as we make progress, we'll certainly sure that, as appropriate. So still working on it, but nothing to update at the moment.

With respect to the Iquvia panel scheduled for July 31, the team is getting ready for the interaction, the dialogue. No new questions, still the same as we discussed before, questions related to long-term safety of the antibodies related to pH 20, and specifically neuronal development in fertility. So nothing new there.

I'm very pleased that you will be able to see all our data. We believe that our data is clean and that we have a positive benefit risk. But as you will be there most likely, we'll have a great dialogue with the FDA.

Great. Thank you, Ludwig.

Thanks.

Rick Wise, Stifel Nicholas.

Good morning, Bob. How are you doing? Bigger picture first. You're clearly investing heavily on the biosciences side pre-spin, seemingly on the surface a little less so in medical devices, although obviously Gambro is a big investment that you're integrating. So definitely, you're actively supplementing biopharma ahead of the spin. Should we expect that Medical Product business development opportunities could come before the spin, too, or are you going to focus on that post-spin?

And maybe just as part of that, as long as I'm laying it all out here, it sounds like you're interested in M&A, what areas are you likely to be thinking about? Something directly related to the existing business or broadening the scope of the post-spin med device company? Thanks.

Yes, Rick, thanks for the question. Several things. Obviously, Gambro's the largest acquisition in the history of the Company, so that really expresses an investment, I guess, in new BAX. But I think maybe what's isn't appreciated as much is in the R&D area, the nature of the investments have been really in new systems, home hemodialysis, the VIVIA system, which we're really excited about, has been a five-year investment, likewise, the AMIA system, which is our next generation home choice, and so on. So those don't jump out in the way that our biopharmaceutical investments do. But we have been making meaningful investments in internal R&D, those being just a couple examples.

Relative to business development activity going forward, we continue to be open to that despite, as you say, and we all know, our primary focus is the spin. I'm not suggesting we won't do anything, but if we do, it will be of a smaller nature. Longer term, we think there continue to be opportunities within the two core areas, which are treatment of end-stage renal disease, as well as the hospital channel.

With the movement of the BioSurgery business over to the new Baxter going forward, very few companies can represent the breadth and diversity of products that are sold in the acute care hospital. And so from acquisition business development point of view going forward, that will continue to be, I think, a major area of focus to further solidify the channel.

I'm not sure what percent of all healthcare dollars are either spent or driven through the acute care channel, but it's a very high percentage. And as I say, very few companies have as strong of a presence and platform, from a channel perspective, there as we do. So I think it's fair to say, at a very high level, that will drive our business development, including acquisition efforts, going forward.

I would just point out that I did mention in my prepared comments that in addition to the SG&A and R&D investments, we are making investments in operations within Medical Products. We are seeing very strong demand, particularly in the US, for IVs in PD, and we're seeing a regulatory environment raising the bar on everything from production through logistics. So there are incremental investments going in to that, as well.

All right. And just to follow-up quickly on Renal. Bob Hombach, as you said, PE gains were very strong in the quarter, up 15% in the US. Is that kind of growth sustainable? Maybe help us understand that, and help us understand a little bit more about the timing issues OUS. Do they swing back positive in the second half? It didn't happen in the second quarter, but now they have happened? I'm not sure I fully understood what was going on there. Thank you.

Rick, I'll comment on what I'll call the market trends, and then if Bob wants to add some color in terms of specifically the financial flow and so on, he can do that.

It's fair to say that globally, not just the US, but globally, there is a movement into more treatment in the home. Whether that's perineal dialysis or, over time, home hemodialysis. And you see a number of countries, Thailand being one, Taiwan being another, that put -- in Thailand, the case of Thailand, what they call PD first, which says, look, as we provide access to treatment of end-stage renal disease, the government policy is going to drive treatment in the home. Because it's a general feeling that it's lower cost, it certainly is greater convenience for patients, and in some cases, and we believe very strongly in terms of home hemodialysis, we're going to be able to demonstrate advancing clinical outcomes in a meaningful way, such as life expectancy and so on.

But you see the same dynamics going on in the US. And so in response to the first part of your question, Rick, yes, I think the strength that we're seeing in the US market for PD clearly is going to continue. I think it's driven by a rebalancing of the reimbursements, so now there are economic incentives for the providers to be in PD in ways, in the past, there were not.

And then of course, with our launch over time of home hemodialysis, I think has further accelerated the growth. So simply stated, in the US, I think the strength you're seeing is not a transient effect. I think it's a representation of some more longer-term environmental trends and gives us confidence that kind of growth is sustainable. Bob, you want to comment maybe more specifically on the numbers part of the question?

So as it relates to PD patients in the US, we've seen a pretty consistent trend over the last five or six quarters of high single-digit, low double-digit PD patient growth. So that demand is there.

With the harmonization around reimbursement, we've certainly seen a very strong move in the US, in particular. So I don't think 15% is necessarily sustainable, but certainly high single digit, low double-digit PD patient growth here in the near-term is certainly a possibility. And OUS, given the mix of revenue that we get per patient in different markets, whatever the renal sales number we're reporting, you can be assured that the patient growth is probably a little faster, for all the reasons that Bob just mentioned. So we are globally seeing very strong PD patient growth, but particularly in the US.

The other thing I would mention again from a macro perspective is that in many emerging markets and developing markets, you have a lot of patients that aren't even being treated today. So it's one of the reasons we made the investment in Gambro that we did. This is a large market. It's going to continue to grow. By virtue of the Gambro acquisition, we have established a leadership position in this market, augmented by the exciting launch of some new products, such as VIVIA in the home. And I think it's a good bet that we made long-term.

Last thing I will add. Second quarter is somewhat depressed, because of a timing of a tender, as we talked about, in Q1 related to Renal. So I'd really look at year-to-date sales as being more indicative of the trend.

Yes. Good point.

Sam, we have time for two more questions.

Certainly. Kristen Stewart, Deutsche Bank.

Hello. Thanks for taking the question. I just wanted to check, with respect to the spinoff, at the time of the announcement, you guys had commented that you did not anticipate being able to redomicile the BioScience businesses. Is that still the case or have your thoughts changed at all?

No change. Certainly, just as a function of a spin out, that is not an opportunity to do a tax-free redomiciling. So that's not on the radar.

Okay. And then just on the IG business, can you comment a little bit about what you're seeing in terms of the dynamic between price and then the supply in the marketplace? Because it sounds like price has been a little less favorable than what it has been historically, particularly within the US.

Yes, I would say we've had very modest expectations on price in the US over the last couple of years, and in our longer range outlook assume that, as well. So I think that remains largely consistent. We're looking forward to having enhanced supply here as we go forward.

We 're able to support market growth here in 2014 and 2015 with our current footprint. And we continue to work with Sanguine to bring flexible capacity online, which we expect in 2015 to be able to provide not only for the US, potentially, but certainly for Europe and other markets. So we're pleased with where we're at from a capacity standpoint and the flexibility we're going to have going forward. And again, from a price perspective, I think largely in line our expectations.

Bruce Nudell, Credit Suisse.

Good morning. Thanks for taking the question. Ludwig, one question for you. Just to clarify, you framed the [oloctate] impact as high single digits in the US. I guess just to clarify, is that high single-digit market share in the second half, or is that averaged over the whole year, or is that actually in fact a worldwide impact?

The single digit market share impact is for the US, and that is between now and the launch of 855.

Perfect. That's great. And Bob, one of the things that, just looking at the numbers -- and it's not a very insightful observation -- but when you look at the Renal business, it is so heavily ex-US. Could you broadly speak about the opportunities in the US now that Gambro's part of the fold?

Yes, Bruce. Some of this is consistent with my response earlier, I think it was to Rick Wise's question. For the first time over the last year or so, largely as a result of reimbursement changes and so on, we're seeing really a boost to our PD business. We look forward to that being augmented by the home HD launch. But there's a lot of things that now for the first time in the US are actually driving consideration of treatment in the home, whether that is PD or HD, which is very exciting. Because frankly, the US business for Renal for us has been pretty lackluster over the last number of years, but as has been demonstrated and I think Bob Hombach cited some of the growth numbers for PD patients, we're really seeing that business get re-energized. And again, as I commented in my response earlier to Rick, we think that's going to be sustainable.

Thanks so much.

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