百特醫療 (BAX) 2003 Q3 法說會逐字稿

Good morning, ladies and gentlemen. And welcome to Baxter International's third quarter cash flow and earnings conference call. Your lines will remain in a listen-only mode until the question and answer segment of today's call. At that time, if you have a question, you will need to press star then the number 1 on your touch-tone phone. 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 your call over to Mr. Neville Jeharajah, Vice President of Investor Relations at Baxter International. Mr. Neville Jeharajah, you may begin.

Thank you, good morning, everybody. By now I'm sure you've seen a copy of our press release for the third quarter of 2003. As the press release indicates, comments regarding the outlook and then forward-looking statements and our actual results could differ materially from our current expectations. Please refer to our recent SEC filings for more details. Now let me introduce Harry Kraemer, Chairman and CEO of Baxter International.

Thank you, Neville. Good morning, everyone and thanks for joining us this morning. In summary, for the third quarter of 2003, Baxter's financial results were in line with our expectations. Our Q3 sales growth expectation was 8 to 12%. We finished at 9%. The Q3 EPS from continuing operations, expectation was between 45 cents and 50 cents and we came in at 47 cents, which was a 8% decline from the third quarter of last year. And cash flow from continuing operations, which we had an expectation of achieving $1.2 billion for full year 2003 is on track. We achieved Q3 cash flow from operations of $463 million, year to date cash flow from operations, $668 million.

Before Brian summarizes our Q3 financial performance, I'd like to provide you with an update on the progress we have made on four major concerns investors have raised and why I believe we are very well positioned going forward. Specifically, the four questions that have consistently been raised are number one, how is Baxter dealing with investor concerns regarding financial liquidity and the balance sheet? And is Baxter improving its capital structure? Number two, are Baxter's accounting practices appropriate? Number 3, given the changing dynamics in the plasma proteins industry, what is Baxter doing to improve the profitability of the plasma business? And number four, how well is Baxter positioned to grow the recombinant business profitably over the long-term?

Now, let me address each of these questions in more detail. In terms of question number one, how is Baxter dealing with investor concerns regarding our financial liquidity and balance sheet and how are we improving our capital structure? In summary, we have a very strong balance sheet today. We will further strengthen it by continuing to actively simplify our capital structure. We remain committed to using simpler financial instruments in the future. For example, we retired the $800 million of convertible putable debt. We've exited all equity-forward agreements. There will be no equity-forward agreements in the future. The $150 million in synthetic leases are now directly on our balance sheet as of September 30. We have reduced our net debt to capital ratio from 46.9% in the first quarter to 42.7% in Q3. Our goal is to achieve a 30% net debt to capital ratio within the next 12 to 18 months. In summary, all of these factors demonstrate our liquidity, strong balance sheet and financial flexibility both today and in the future.

Question number two, are Baxter's accounting practices appropriate? Our accounting practices and policies are in accordance with both GAAP and SEC requirements and our accounting practices have always been consistently applied. For example, as part of our September 2003 equity offering, the SEC completed a full review of our financials. As a result of their review, there were absolutely no changes to our accounting policies or any restatements to our financials. This is consistent with all SEC reviews we have completed over the last 20 or more years. That is as far back as at least I can remember in the 21 years with Baxter. In summary, Baxter's accounting practices continue to be very sound and completely consistent with both GAAP and all SEC requirements.

Question number three, given the changing dynamics in the plasma protein market that is the market moving from supply constraint to excess supply, what is Baxter doing to improve the profitability of the business? We've taken several specific actions to improve our profitability and returns and are starting to see the benefits of these actions. For example, we announced the restructuring charge in the second quarter and reduced the amount of plasma we fractionate by completing the shut down of our Rochester fractionation facility and closing 26 plasma collection centers. We've seen evidence that the plasma industry continues to consolidate. As a result of our newly-created IGIB sales force and focused on the home care market, IGIB unit volume has increased 5% year to date and we expect Q4 to be even stronger. Pricing has stabilized over the last nine months and we expect this trend to continue. The [alp] acquisition is expected close in Q4 and will further improve our overall plasma economics. In summary, despite the volatility in the plasma protein market during the last year, we have taken very specific actions and we are beginning to see the benefits of those actions.

Question number four, how well was Baxter positioned to grow the recombinant business profitably over the long-term? I believe we are very well-positioned as the global market leader for recombinant factor 8 with very strong growth and significant returns. For example, as you all are aware, Advate was approved in the United States at the end of July and was launched at the end of August. We expect the committee for propriety medicinal products, CPMP, to issue a positive opinion in Europe in the fourth quarter. The U.S. launch is going well with positive feedback from both clinicians and patients on the preference for Advate. Home care companies have signed long-term commitments for Advate at expected premium pricing. 44 states have approved reimbursement for Advate under Medicaid. In the first half of 2003, recombinant sales growth was 4% as we had discussed much of that reduced sales growth was related to the reduced inventory being held by distributors. For Q3, our sales growth was 14%, our Advate sales in the third quarter was $11 million. As a result of our performance in the third quarter, we expect recombinant sales growth to exceed 10% for the full year. Also, by 2006, we expect Baxter's recombinant sales, that is a combination of recombinant and Advate, to be approximately $2 billion with sales of Advate alone exceeding $1 billion. In summary, we are very well positioned as the global market leader for recombinant factor 8 with strong growth and significant returns.

In conclusion, I believe we have made significant progress in these areas and will continue to focus on making further improvements. I am confident in our ability to continue to deliver shareholder value going forward. At it a point in time, I'd like to turn it over to Brian Anderson to take you through the financials.

Thank you, Harry and good morning, everyone. As Harry just stated, our Q3 results were in line with the guidance that we provided earlier and I'm particularly pleased with a very strong cash flow performance in the quarter that I will get into in a few minutes. First, however, let's start with the P&L, which is detailed on page 7 of the press release. Sales growth for the total company was 9%, including 3 percentage points of benefits from currency. International sales growth was 9%, 2% excluding the impact of currency and domestic sales growth was 10%.

Now let's look at sales performance for each of the businesses, all of which were in line with our previous guidance. First, medication delivery, once again, delivered very strong sales growth across all of its key business units. Q3 sales for medication delivery was $948 million, and increased 16% with solid growth in IV therapy of 13%, drug delivery was up 19% and they launched several new products so far this year within drug delivery. Anesthesia growth was 44%, benefiting from a very successful acquisition of ESI Lederle, which continues to go extremely well.

Turning to Renal. Renal sales growth was also consistent our expectations of $451 million in the quarter for an increase of 4%. PD growth was 4% and HD growth was 1%. Within bioscience, as Harry just discussed, we continue to see very strong improvement given the strong recombinant sales and stable plasma pricing. Q3 sales for total bioscience was $820 million and increased 6%, an improvement over both Q1 and Q2. Transfusion therapy sales were 3% and recombinant sales were $291 million, increasing 14% in the quarter, including the benefit of about $11 million in sales from Advate. This is the highest quarterly dollar sales for recombinant and with a ramp of Advate, we expect Q4 sales to be even higher. Antibody therapy increased sequentially to $77 million in Q3 from $71 million in Q2. And IGIB pricing has now been stable for the last nine months and we expect that to continue.

Now turning to gross margins, the gross margin rate in the third quarter was 43.8%, in line with our expectations and the 43.8% in Q3 compares to 45% in the second quarter of this year and 46.3% in the third quarter of last year. The 1.2 percentage point decline in gross margin from Q2 of this year to Q3 of this year is primarily due to the geographic mix of sales between quarters. And as we have said in prior quarters, the year-over-year decline of roughly 2.5 percentage points is predominantly driven by the pricing declines in the plasma business that we've talked about and to a lesser extent, geographic mix. Obviously we're doing everything to improve margins going forward. SG&A expenses, as you know, we announced our restructuring at the end of the second quarter, which will reduce our global head count by roughly 3200 people and about half of these are in SG&A areas, based on our objectives to get much better expense leverage, given our current sales levels. Based this much more aggressive management of expenses and the initial restructuring benefits, SG&A spending declined by $26 million in the third quarter from our spending level in the second quarter this year. And the SG&A ratio was 19.7% of sales in Q3 of this year compared to 21.5% in the second quarter and 20.7% in this year's first quarter. So far, I'm very pleased with the progress we are making in expense management and our progress in implementing the restructuring and we are on track to achieve the restructuring benefits of 5 cents per share this year and 15 to 20 cents per share in 2004.

Research and development spending in the quarter was $137 million, relatively flat to both the first and second quarters of this year and up 13% over last year. The operating margin in the third quarter was 17.9% compared to 17.1% in Q2 and 16.6% in the first quarter of this year. Year-over-year, the decline in operating margin is obviously due to the gross margin decline and the higher SG&A ratio that I discussed earlier. Reactions we're taking are definitely expected to continue to improve our operating margins going forward. Sundry in the quarter was $6 million, very consistent with last year and net interest expense was $25 million, similar to Q2 of this year. The tax rate is 24%, very consistent with prior quarters.

With respect to share count, with the adoption of FAS 150, we finished the quarter with diluted shares outstanding of 592 million, slightly less than the 600 million we stated during our recent road show. As Harry said, we exited all remaining equity forward contracts in Q3, using some of the proceeds from the equity offering that we completed in September. Earnings per share, diluted earnings per share in the quarter was 47 cents compared to our guidance of 45 to 50 cents. Cash flow from continuing operations, before turning to the cash flow statement, I'd just like to refresh your memory that on last quarter's conference call, I outlined our increased focus on our balance sheet and cash flow performance, specifically I discussed our action plans related to receivables, inventory management, most notably our capacity reduction in the plasma business, accounts payable and capital expenditures. As a result of all of these actions, I'm very pleased with our progress, but we obviously still have work to do. Cash flow from operations each quarter this year with an outflow of $22 million in the first quarter and the second quarter we generated $227 million and in the third quarter we generated $463 million, resulting in our year to date cash flow from operations of $668 million, which is $210 million better than last year, year to date performance.

Now, let's look at some of the details on page 7 of the press release. As I just said, cash flow in the third quarter was $463 million, which is more than double what we generated in the second quarter. DSO at the end of the third quarter this year was 64.6 days and declined 1.2 days compared to the second quarter. And on a year to date basis, receivables declined $4 million this year compared to an increase of over $228 million in last year's year to date period. Although inventories increased slightly in the third quarter compared to Q2, inventory turns improved from 2.2 turns to 2.3 turns and as I said last quarter, it will take us three to four quarters to realize the full benefits of the capacity reductions in the plasma business that was part of the restructuring. The Rochester plant is now closed and we have closed all of the 26 plasma collection centers. Notably, in the third quarter of this year, there was no incremental working capital consumption compared to the incremental working capital of $440 million in the first half of the year. So, I feel very pleased with our progress in working capital management. Year to date, capital expenditures were $562 million, basically flat to last year and for the full year, I expect Cap Ex to be in the $750 to $800 million range. Year to date depreciation and amortization was $399 million, compared to $325 million last year and for the full year 2003, I would expect depreciation and amortization expense to be 15 to 20% higher than last year. As I said on last quarter's call, based on all of the actions that we're taking, I have a very high level of confidence in our ability to meet our cash flow objective of generating more than $1.2 billion in cash flow from operations for full year 2003. And much more importantly, we intend to improve this performance going forward.

As it relates to the outlook for 2003 full year, sales growth in the 8 to 10% range and this is no change to the guidance that we gave on last quarter's call. And no change in each of the respective business segments. Renal, in the 2 to 5% range. Medication delivery in the 12 to 16% range. And bioscience 5 to 10%. Earnings per share from continuing operations, the full year guidance continues to be $1.65 to $1.75. The diluted average share count for the full year will be approximately 610 million shares and cash flows from continuing operations will definitely be in excess of $1.2 billion. Our full year outlook, obviously implies a very strong performance in Q4, which will be driven by even stronger sales in medication delivery, including very strong growth from job delivery, ESI Lederle and the significant historical ramp that we have in the fourth quarter relating to our hardware business. We expect continued stable pricing and increased unit volumes for IGIB in Q4 compared to last year and recombinant sales growth in Q4, including Advate, will be in the 15 to 20% range. Because of all these factors, I expect operating margins in Q4 to improve as a result of the more favorable sales mix, improved margins and generating savings both from our aggressive expense management as well as the benefits of the restructuring that we announced in July. Now I'll turn it back to Harry for his summary before we take your questions.

As Brian and I have outlined, we believe we have made significant progress over the last several quarters and we clearly have more work to do. We are very focused and disciplined in our approach. We are particularly focused on significantly improving Baxter's profitability, that is our gross margins, expense leveraging and our operating profit ratio as well as cash flow from operations and our returns going forward. In fact, I believe that each of the businesses are well-positioned for the future. In terms of our bioscience business, we have discussed the actions we have taken to improve profitability within the plasma protein business, IGIB pricing has been stable over the last nine months and volumes have increased. We expect to close the Alpha therapeutics acquisition in Q4, which will further enhance our plasma economics over the long-term. The Advate launch is going well and we expect a positive opinion by the European CPMP in Q4. And we continue to make progress on our R&D initiatives, including influenza and liquid IGIB, which will further strengthen our portfolio and franchise. Our established competitive advantages in our bioscience business, we believe, will continue to drive sustainable market leadership going forward.

For medication delivery, continued strong performance across multiple businesses consistently delivering very solid performance. The acquisition integrations are going very well, including cook pharmaceuticals and ESI Lederle with significant growth in return potential. We are very pleased with our premiere awards. The five-year $2 billion award for ID solutions, sets, pumps and nutrition as well as the $700 million three-year award for anesthesia products. We also have strong growth in drug delivery. We continue to add capacity in Bloomington, Indiana. We've signed several new pharma contracts with 38 more under development and 45 more under negotiations. We have already launched five new products this year and expect to launch two to three new drugs per quarter. As a result, I expect our drug delivery sales to more than double to $1.4 billion by 2007.

Finally, we continue to capitalize on our leadership position to drive sustainable growth in the global medication delivery business. For Renal therapy, while the sales growth rate is lower, this business leverages Baxter's strong manufacturing position and generates very strong cash flow and return. We expect improved profitability given the divestiture of the service businesses. Over time, we expect growth to accelerate as we penetrate markets with new product launches in both PD and HD.

In summary, focus on strengthening our balance sheet and improving liquidity will continue. We are improving the plasma protein profitability. We're further enhancing our market leadership position in recombinant factor 8 market with the launch of Advate. We're setting a strong foundation for future growth that is profitable, sustainable and capital efficient. I believe that this focus and consistently delivering to our expectations will result in increased returns in the future. In this point in time Brian and I will be more than happy to take any questions.

Thank you. We will now begin the question and answer session. If you have a question, you will need to press star 1 on your touch-tone phone. You will hear an acknowledgement that you have been placed in queue. If your question has been answered and you wish to be removed from the queue, please press star then the number 2. If you are use using a speaker phone, please pick up the handset. Once again, if there are any questions, please press star, then the number 1 on your touch-tone phone. Matthew Dodds from SG Cowen is on-line with a question. Please state your question.

Good morning. First, on the gross margin, Brian, third quarter you said that it was down because of mix, but the U.S. was up $70 million sequentially. So, I'm wondering with are the U.S. gross margins lower? Or is this mix outside the U.S., in other geographies?

The general mix is outside the U.S. and margins outside the U.S. and many of our markets around the world are actually stronger.

And then on drug delivery, given, Harry, your comments on the 3 to 4-year total number, that business has been growing over 20% recently organically, is that a rate of growth near-term we can expect or are you talking about this actually accelerating?

I think it is very fair to assume, Matt, that that growth will continue in excess of 20% on an annual basis.

Is there any one product in there hat you can highlight, that over the next three to four years is going to be a significant chunk of that? Or is this just a number of products?

It's a number of products. If you think about the comment I made, Matt, of just the sheer number, given the number of agreements we have with both the pharmaceutical companies and biotech companies, virtually every major company now has a contract with us.

And the benefits of the Cook acquisition.

Absolutely.

Thanks, Harry, thanks, Brian.

Dan Lemaitre from Merrill Lynch is on-line with a question. Please state your question.

Good morning, everybody. One housekeeping chore and then a forward-looking question. But maybe, Brian, could you just give us the specific top line currency benefit for each of the sectors?

It pretty much is uniform across most of the businesses, Dan.

So, the total currency benefit, specifically, was what, about $73 million, then?

It -- 2 to 3 points of impact.

Okay. And then just going forward, just a couple of comments about the fourth quarter if you will and specifically you talked about a share count of 610 for the full year. Which, since you've ended this quarter with 592, should we assume the share count bounces back up in the fourth quarter or does it hold at 592? It seems you could average something close to 600 for the year if that was the case.

It bounces back up to the rate similar to what you saw in Q1 and Q2. The only reason for the lower share count in Q3 was the adoption of FAS 150, where we put the equity forwards on the balance sheet after July 1. Followed by the timing of our equity offering which occurred later in the quarter. So, really is just the mechanics of the weighted average throughout the quarter, driving to the lower number and in Q3.

Got it. And just lastly, just anybody want to take a shot at what we ought to think sequentially for Advate sales in Q4?

We'll let you know, Dan, when we finish the year on our January call, exactly what Advate sales were for the fourth quarter.

Okay, Harry. Thanks!

Rick Wise from Bear Stearns is on-line with a question. Please state your question.

Good morning. A couple of questions. First, can you help us understand the 5 cents or so of restructuring benefit? What portion did we see -- I'm sorry, what portion did we see in the third quarter? And what will we see in the fourth quarter? Is it all in the fourth quarter?

It's going to be much more loaded toward the fourth quarter, Rick, because obviously, you know, we announced this charge in July and, you know, the benefits are definitely, you know, less than half in the third quarter, just given the timing of how this ramps. So, it's going to be predominantly in the fourth quarter, which is one of the factors leading to the improved outlook for Q4.

And that's mostly in gross margin?

Primarily SG&A.

SG&A. And help us understand, again, you know, to get to your range in the fourth quarter, it's a significant sequential improvement, I mean I heard the comments on sales. Is it mostly gross margin? Or lower costs? Where's the -- where's the bulk -- the major driver getting to you to such dramatic sequential improvement?

Well --

As we're thinking about modeling the fourth quarter numbers.

Yeah, the major driver is definitely incremental sales for all the reasons that I described for each of the businesses. And those sales will have a richer gross margin mix and so margin will be a significant contributor, as well. And on expenses, we're aggressively managing expenses and in addition to that, you get the benefit of the restructuring kicking in. So, the operating margin sequentially is going to be significantly better.

Rick, one of the things that Brian had mentioned earlier was that the recombinant growth, both a combination of recombinant and Advate, we expect to grow between 15 and 20% in the quarter and you already had some pretty good sense of what the gross margin impact of that is.

Yeah. And just last, can you help us understand if you -- just -- as you often say, peeling the onion, Harry, the core growth, excluding acquisitions, help us understand exactly what contributed in the quarter?

In the quarter, about $50 million.

Was acquisition?

Yes.

Okay. Thank you very much.

It was basically ESI, Rick.

Bob Goldman from Buckingham Research is on-line with a question. Please state your question.

Thank you. I just wanted to follow up on the SG&A improvement in the fourth quarter. It seems to be due in part to restructuring savings and in part due to, as you say, you know, cost control. I'm wondering if you could, you know, give us some sense of direction more on SG&A. Is it, in fact, expected to be sequentially down? And whatever the improvement is, you know, what percent is coming from the restructuring benefits and what percent is coming from everything else?

The ratio to sales will definitely be down and probably about half of that is going to be associated with restructuring benefits and the other half just on, you know, tightening down on expenses across all of the businesses.

And if I can, just quickly follow up, will the dollars on SG&A, as well, be down sequentially?

No, because the sales are going to be up significantly in the fourth quarter.

Okay. Thank you.

Uh-huh.

Ben Andrew from William Blair is on-line with a question. Please state your question.

Good morning. Harry, can you talk a little bit about the Advate rollout and sort of what efforts you've been making in the marketplace with both the sales force and also working with insurance companies? You did mention some good numbers on the state payers, but maybe talk a little bit about the private payers and how you think the trends will accelerate into the fourth quarter? Because obviously there's good growth expected there.

Yeah, fair question, Ben. I would say overall it's going extremely well, the marketing group has been making a significant amount of progress, meeting with all of the major patient groups, all of the major providers and payers. As you heard what I mentioned related to the Medicaid, we've met with the great majority of the private payers, Ben, and at this point in time, reimbursement is in extremely good shape. When we take a look at what we would expect to be able to do and what has happened so far, we believe we're right on target to doing that. The key thing now, Ben, at this point point in time is just given the relationships with the patients, given the relationships with the distributors, now we're very focused on making sure, as the individual patients come in for their, you know, once or twice-a-year meetings with their doctors that we have a very gradual, very continued penetration of that marketplace. Both converting some of our recombinant product, some of our competitors recombinant product and as I mentioned earlier, continuing to increase the penetration of the plasma-based product. So, right now I think everyone feels extremely comfortable with the level of supply in the marketplace. I'd say right now there's a lot of confidence that not only is the product doing everything we said it would do, but that the supply is sufficient and then again, as we get to the approval in Europe, we believe we're very well positioned and we're spending a tremendous amount of time, Ben, from a marketing standpoint at getting ready for the European launch, as well. So, I'd say early days, Ben, but so far, so good.

And a quick question for Brian. You talked about high confidence in the $1.2 billion cash flow from continuing ops this year. Can you point us a little bit toward next year, can it be as high as 1.5? And maybe give us your thoughts on Cap Ex for next year. Thanks.

Definitely it will be higher next year and I think significantly higher. We will get into the detail of that on our Q4 call. But the actions we have taken I feel very good, especially the comment I made about no incremental working capital this quarter and that's going to be a big driver for us as we continue to improve performance on receivables and we get the benefits of the actions that we've taken in plasma on dealing with overall inventory levels.

And can you give us your target for next year, DSOs and churns and things like that?

I will get into that on the January call. Cap Ex, we said before, that we will drive that down to 6 to $700 million next year.

Thank you.

Glenn Reicin from Morgan Stanley is on-line with a question. Please state your question.

Good morning. Two questions. First, do you mind just going through some of the major product lines and telling us about domestic, international growth among those product lines?

On page 9, Glenn, we break out the key product lines, in fact, the top 10 product lines with growth for both the quarter as well as year to date and page 8 breaks out the growth for each one of the major business U.S. international.

Right, but can you actually help us peel the onion a little bit further?

No.

Tell us what -- you won't?

No.

Okay, next question. Can you tell us what the disclosure will be this quarter on the net hedging losses? Explain a little bit about why you entered into these hedges in the first place and how big does the loss have to be before you feel you to exit these things?

I think it's best to have our Corporate Treasurer, Steve Meyer, take that one.

Hi, Ben, I'm not going to give you exact numbers today for the quarter, but what I would like to say is that the hedging that we've done, because of the scope of our global operations internationally, is very consistent with what other large global companies do. I know in the past you focused on other healthcare companies. If you do a detailed analysis of theirs as we have, you will see this is an extremely common practice and I'm very comfortable with the position that we have.

So, the losses can get larger and you feel no obligation to try to get out of these hedges?

I think what's important to understand, Glenn, if you put the pieces together, whatever we have on that investments is a partial hedge. The underlying assets are growing stronger. So, if you see a reported loss, the underlying assets are actually stronger than that. So, I feel very comfortable with the position.

I understand that, but you have a mismatch in terms of timing. These are long term assets. You have no intention of selling, versus a short-term financial instrument. Can you just explain why you entered into the contract in the first place?

We entered into the contract as we do all our hedging, to reduce volatility, to reduce risk. We do not have a mismatch. Again, if you look at the working capital levels we have internationally, there is zero mismatch and we have never had a problem in extending the durability and reliability of this. We did a euro bond issuance. When you do international bond issuances, the effect is exactly the same. I encourage you to look at disclosures of other large healthcare companies because this is extremely consistent.

Thank you.

Mike Weinstein of JP Morgan is online with a question. Please state your question.

Thank you. I have actually a couple of questions about the guidance, but let me follow up on Glenn's question regarding the net hedges. Is the answer you entered into the contracts to hedge your debt to capital ratios?

I think that's definitely one of the biggest benefits, is to maintain a consistent debt to cap without volatility, additionally, Baxter has a history of repaying treated earnings with the amount of cash flow and earnings we generate offshore, trying to maintain and reduce volatility on our dividend from offshore.

Okay. So, -- and let me switch to your fourth quarter guidance again, which you addressed I want to be sure we're clear. The company's guidance appears to be 75 to 85 cents for the quarter, is that right?

Well, you can do the math as well as we all can.

Okay. If I'm wrong, please tell me.

Okay.

And you're saying for the fourth quarter revenue growth of 1?

I think we've said that for the full year it will be 8 to 10%. Again, we will let you do the math, Mike.

Okay. And I'm doing the math, Harry, I'm not necessarily as good at math as some people at Baxter might be, but I'm still struggling. If I look on the third quarter, where the cannot earned 47 cents and to adjust the share count for what the share count will be on a going forward basis and that makes it 45 cents I say well, okay, the company's got this restructuring which is going to add maybe 4 to 5 cents in the quarter. So, it is add 4 cents on top of it to get the 49 cents. And I still say that in order to get to that 75 cent numbers you're going to show in the fourth quarter, you have to add what is $210 million in pre-tax profits. And that's on an incremental revenue base that, you know, maybe will be $300 million, maybe it's 250 to $300 million. Is that math accurate? What am I missing on the math?

Mike, I guess what I would say is we're trying to give you the best sense we can of each one of the businesses. What we believe will happen in terms of growth and the trends. We will let you do your own analysis.

I understand your response, but just tell me where are we off versus with what the company is saying?

Again, I'm not going to do your analysis, Mike.

That's -- that's very fair.

If you have a specific question, Mike, go ahead. I'm not going to respond to your analysis.

Okay. What will drive the company's operating margins substantially higher in the fourth quarter?

The improvement in our operating margin for the fourth quarter will be a combination of the growth in drug delivery, ESI Lederle and hardware, all of which have a higher than average gross margin. The gross improvement in gross margin will be driven by a higher growth rate in our recombinant business, which will grow between 15 and 20% at a significantly higher level of gross margin. The overall level of SG&A as a percent of sales will improve as a result of the comments that Brian made, both in terms of the expense leveraging within the company as well as the restructuring. And a combination of those things will generate for us a higher level of sales growth and improved gross margin, a significantly leveraged SG&A and a significantly higher level of operating margin. Beyond that, Glenn, Mike, everyone, that's as much as I will tell you.

In fact, Mike, I will add one thing to that. The currency benefit in Q4 would be the lower of the four quarters. So, sales growth will translate into higher earnings because of currency benefits being less.

Very good. Thank you.

Larry Keusch from Goldman Sachs is on-line with a question. Please state your question.

Yeah, hi. Harry, thank you very much for spending time on some of the concerns that are out there. I'm wondering if you could just potentially speak to one more, which is: You know there, have been folks that are concerned about the inventory levels and you haven't taken a write-off yet in plasma, but I wonder if you have any thoughts there? And could you need to? Or do you really feel comfortable that the way the business is being managed now you can work through that high inventory level?

Thanks for the question here, Larry. A couple of things, as you correctly indicate, inventory management, in fact, all working capital management is a very high level of improvement opportunity for us. You heard Brian's comments earlier related to working capital and, Larry, you're correct that the inventory piece is a substantial opportunity. We've been working aggressively at that within medication delivery and renal within the bioscience area, Brian working very closely with the bioscience folks, particularly now related to the restructuring, the closing of the Rochester facility and the reduction in plasma centers. We believe there's a significant opportunity in terms of our overall inventory management within bioscience.

Yeah, Larry, I agree with that fully and I don't really see the risk of significant inventory write-offs that's going to affect our ability to meet our expectations as we set them. Obviously we're doing a lot as it relates to capacity and I'm certain that with sales growth across some of these product lines, we do expect to reduce inventories going forward.

Okay. Great. Thank you. And then just two quick questions for you. Just back to the SG&A question, when we're thinking about the fourth quarter, obviously you -- I think you said earlier that SG&A would be up sequentially just because of the rise in sales. But should we be thinking about the growth as less than the sales increase?

The ratio will definitely improve-- improve significantly. The year-over-year growth, there will still be significant growth year-over-year, but we're going to see much more efficient leverage of SG&A in the quarter compared to the prior three quarters of this year.

Okay. Great. And then lastly, it s there any just update on the SEC investigation?

No. But as we -- again, as we get additional information, we will keep you informed.

Okay. Thanks, guys.

Ed Huber from Wachovia is on-line with a question. Please state your question.

Good morning, thanks. Just quickly back on the fourth quarter, I want to make sure I understand if the four cents of non-operating charge in this third quarter, how that plays into the range of 165-plus for the year and really, Brian, I want to get a sense of what was the operating target for the fourth quarter in terms of EPS? There is a lot of moving parts here. Would it be 75 cents at the low end of the range?

Well, the full-year guidance is $1.65 to $1.75 and the 3 cents related to the accounting changes for the adoption of, you know, the accounting required for the equity forwards and the synthetic leases, is not a part of that. And never, you know, no company -- and we never have included the cumulative effect changes resulting from accounting changes in our guidance. That 3-cent impact is excluded.

Okay. That's helpful. And then also, just one other thing on fourth quarter. Can you give us an operating margin target or range that you think is appropriate?

For -- just for the fourth quarter --

Just for the fourth quarter alone, that's right, yeah.

Continued sequential improvement. The fourth quarter is always our strongest quarter for operating income as a percent of sales and that will continue.

You can't quantify that? It looks like it's got to be 23, 24, in that range. Is that fair?

Well, as I think Harry said earlier, you know, we aren't going to work the specifics of your models for you. It's going to be north of 20% for sure.

Okay. One last question then, fourth quarter. In the 15 to 20% recombinant growth, can you specify what the underlying assumption relative to the European approval is? Does that include revenue out of the European theatre for Advate? And could we get to a point where you have to change the numbers if that approval doesn't come through in time for the fourth quarter?

The expectation is very little sales in Europe in the fourth quarter.

Okay. Thanks, gentlemen.

Sure.

Glenn Navaro from Banc of America Securities is online with a question. Please state your question.

Thank you. I just had a couple of follow-up questions on Advate. The $11 million that you reported in the quarter, I'm assuming this is wholesale or -- wholesale or stocking. Is this correct? And when do you get visibility on true patient adoption? Then, in the last quarter you talked about inventory levels at the distributor -- distributor level for recombinant factor 8. Can you give us a sense of, you know, number of days of inventory at the distributors for this quarter? And has that improved or gotten worse from 2Q? And lastly, we've been hearing that Wyet and Byer, in response to the Advate launch have been lowering prices on their products. Are you seeing that and is that having an impact on your business? Thanks.

Sure, Glenn. First of all, you are correct that the overall wholesaler -- or inventory levels of the home care companies were significantly reduced from the beginning of the year toward what we believe is 30 to 40 days. That is definitely staying within that area. Given the overall level of confidence in the supply now that we have, there have really not been any higher levels of inventory held by our customers or by the home care companies. We would expect that to stay where it is as the conversion gradually takes place. And in terms of pricing, we have not had any impact on pricing of our product either for Advate -- well, Advate as you know is being sold at a premium and the recombinant sales price is being held flat.

But just a follow-up, when do you get the true visibility on the patient adoption? So, today, you know, you sold 11 million, but that's mostly wholesale or stocking. Can you give us then feedback or color as to, you know, what the patients are seeing? What they're doing out there?

Well, go ahead, Brian.

Glenn, I think the fundamental assumption you're making that there's been wholesalers stocking and that's what the 11 million is, I think Harry just mentioned given the confidence of supply, what we really have not seen is significant initial stocking. So, you know, that 11 million for the few weeks in the quarter, based on the launch, is really primarily responsive to patient inquiry and user demand.

Okay. Very good.

And obviously there's a slight lag in us getting information from the home care companies and that's something that the launch team is monitoring pretty closely.

And Brian, just one more question for you. I know you may not answer this, but can you give us a sense of the difference between the margins on recombinant and Advate so that maybe it will help us get to the fourth quarter number a little easier?

Um higher!

Higher by 5 basis points, 10 basis points?

I'm surprise surprised, Glenn, Brian gave you that much information.

I didn't think you'd answer the question.

I'm shaken by him telling you that much! We will take two more questions.

John Calcagnini is on-line from CIBC. Please state your question.

Okay. Good morning, guys. Just quick, Brian, the share count for the fourth quarter, just to come back to that. So, are we talking about $625 million in share count in the fourth quarter?

Oh, no.

Because to get to 610, now that -- you know --

It will be roughly 615.

Oh --

It's very comparable to, you know, the first two quarters in that range.

Okay. So the yield will be somewhat less than 610. Can you tell us what the acquisition contribution was from ESI Lederle and over all in the quarter?

About $50 million in sales.

$50 million?

Yeah. And continued to go extremely well.

Is it just Lederle? Anything else in there?

No, that's it.

And you didn't want to quantify the FX impact? I know somebody asked that earlier, but the dollar -- you said 2 to 300 basis points, but you don't want to give us the dollar number?

Well It's roughly $2 billion in sales, so it's roughly 60 to $70 million.

We were looking to be more precise than that. Anything unusual in the gross profit line in the quarter, in terms of inventory write-offs or anything unusual in that margin number?

No unusual inventory writeoffs. Purely just on mix.

Okay. The other expense a little below what we were looking for. Anything unusual there?

No.

Okay.

You're looking for more expense, John?

Well, we had $15 million, but -- you know, I don't want to get too picky. The Cerus program, can you talk about that, where that stands and, you know, what that means for you expectation for transfusion therapies in the future?

Well, overall, John, the -- for the U.S. platelets, we are completing a supplemental trial by the end of '04 and for plasma, both the U.S. and Europe, we're in Phase III, as you know. And also for the red blood cells, both the U.S. and Europe is on hold.

Uh-huh so, we shouldn't expect much of anything out of that program at this point? Or...

In terms of having any -- any material impact on Baxter's financials, no.

Okay. And is the employee reduction is 3200, where are you in terms of number of people that have actually left the company right now? And where have -- how is that split up by division?

Well, we're on track with the timing for these activities and about 2/3 of the 3200 are physically, you know, out of the workforce. Obviously with work's Counsels in Europe and so on, it does take a little longer for the exits to occur, but we're absolutely on track and, in fact, ahead of schedule in some of the businesses. I won't break this out by each business unit, but, you know, it's about half manufacturing and R&D and half SG&A.

Okay. Okay. So, half manufacturing and R&D, half SG&A. Can you talk about the nature of the positions in SG&A maybe a little more? I mean is it mostly G&A?

Mostly G&A across, you know, all of the typical support functions, HR, finance, even though it pains my heart. Certainly as we look at -- at getting more efficient in supporting the businesses, we're going to operate a lot more efficiently and share resources across all of the businesses much more effectively.

What about sales? Has there been any reductions there? And what areas would that be?

Very minor and only where it really makes sense to share resources across particular SBUs. But obviously with our focus on meeting our customers' needs, et cetera, and driving profitable sales growth, that's something we look at pretty -- pretty carefully.

Okay. One just last question. The tax rate was just a tweak lower than we were looking for at 24%. And so is that the sustainable tax rate for next year? 24, is it -- can you talk about next year a little bit on the tax rate?

Next year --

And fourth quarter?

Yeah, next year's guidance we'll get into on January 29. The 24% is -- is really right in line with what you've seen pretty much all year and we will give you the specific guidance on January 29 for next year.

Okay. And --

John, we've got to give someone else --

That's fair, thanks.

Last question.

Bruce Crana from Leerink Swann is on-line with a question. Please state your question.

Hi, good morning. Harry, I know you don't want to comment a lot on Advate pricing, but can you give us some sense in Q4 and your expectations with respect to bioscience? Do you think that when you look at it you look at the Q4 levels of recombinant sales in general, do you think on the Advate side you're -- you know, there's share gain to be made in the U.S.? Or do your expectations contemplate more of, you know, just swapping people up to a higher-priced product?

Well, I think it really is a combination of several things. So, just to kind of give you a perspective. When we take a look at the underlying growth for recombinant product, we see that the market is somewhere between 12 and 15% on an annual basis. As we mentioned, our growth in the first half was less than that, given what we talked about earlier related to the inventory held by the home care companies. Given the fact that's now been flushed out and they're down to 30 or 40 days, you know, we see the individual market growth growing 12 to 15%, given our overall position, given the fact that we now have significant recombinant product as well as Advate, we expect a recombinant growth in the fourth quarter to be 15 to 20%, which will give us in excess of 10% for overall recombinant growth for the year. So, we think we're in very good position there and in terms of the sales, it really is a combination of "A," higher market share. "B," continue to convert product from plasma-base to recombinant-base, some of it clearly will be conversion from recombinant to Advate. Others will be market share gains from our two major competitors. So, I think it will be a combination of all of the above, Bruce.

But you have a sense that you can swap folks out of it or whatever?

Yes.

And I think Brian mentioned Q4 as kind of a ramp, I think his comment was in the hardware sales. I assume that's Fenwall and HD?

Primarily medication delivery.

Oh, so the pump side.

Correct.

Yes.

And can you give us a little color there, what are you anticipating that -- I mean I know it's a very competitive space right now and some change in landscape. What's the dynamic changing there in Q4 for you?

It's what, Bruce, actually this is a piece that's completely consistent with every year. If you take a look at the buying of hospitals and their capital budgets, there is always a significant ramp-up in the fourth quarter. So, nothing unusual there.

Okay. And lastly, any progress on selling the renal service business? I can't recall if you made any headway there or not? And a little update there, if you don't mind?

Yes, we've made quite a bit of headway. We have completed the sale of the service businesses in the U.S. to Davita and some of the centers outside the U.S. we have completed, you know, transactions to -- to exit those activities. And by the end of the year, we'll be, you know, completely finished with the service business exits. We're probably 70 -- 75% of the way done.

So, the remaining amount carried is discontinued as what, if you don't mind?

Yes, it remains in discontinued.

I'm sorry, Brian, what's the dollar amount remaining as discontinued ops?

In terms of earnings impact or --

No, as an asset valuation.

Very small.

Very, very small.

Great, thank you.

Okay. Okay, thanks, everyone. I appreciate everyone's time and look forward to chatting with everybody on January 29. Thank you.

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