百特醫療 (BAX) 2004 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. (OPERATOR INSTRUCTIONS) This call is being recorded by Baxter and is copyrighted material. It cannot be recorded or rebroadcasted 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, Head of Investor Relations at Baxter International.

Thank you, Cynthia. Good morning, everyone, and welcome to our Q3 2004 earnings conference call. Joining me today are Bob Parkinson, CEO and Chairman of Baxter International, and John Greisch, Chief Financial Officer.

Before we get started let me remind you that this presentation including comments regarding our financial outlook contains forward-looking statements that involve risks and of course our actual results could differ materially from our current expectations. Please refer to today's press release and our SEC filings for more details concerning factors that could cause actual results to differ materially. In addition, in today's call non-GAAP financial measures will be used to help investors understand Baxter's ongoing business performance. These measures include gross profit, SG&A, operating profit, fundry (ph), and earnings per diluted share, each including special charges.

In accordance with SEC Regulation G, 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 it is my pleasure to introduce Bob Parkinson.

Thanks, Mary Kay. Good morning, everybody. We're pleased to be with you today to discuss really 3 things. First of all our financial results for the third quarter to provide an outlook for the fourth quarter and the full year 2004, and then to update you briefly on the progress that we are making to get our Company on course and repositioned for the future. At the conclusion of our formal remarks as always, we will open up the call at the end to Q&A where John, Mary Kay, and I would be happy to address any questions you might have.

Before John gets into the specifics of the financial results, let me begin by saying that over the last several months I have had the opportunity to meet or to speak with many of you. I appreciate very much your candid input. I certainly don't underestimate the issues that we face as a Company. The feedback that we have received from you frankly has been very consistent. We hear your concerns. We understand the challenges and we remain committed to regaining your trust and confidence through our actions and results.

Let me briefly highlight some of the key results and important milestones that were achieved during the third quarter. Sales grew as indicated in the release this morning 5 percent, 2 percent net of exchange, and earnings per diluted share were 42 cents, in line with our expectations and consensus. We remain on track to achieve our Q4 earnings guidance of 54 to 58 cents per share, resulting in full year earnings guidance of $1.66 to $1.70 per share. We also continue to see sequential improvement throughout the year 2004 in our gross margin and operating margins and our third-quarter results position us to achieve our cash flow objectives for the full year of 2004.

The restructuring program continues to achieve its key milestones and will achieve the savings levels in 2004 and beyond that we previously communicated. Again to remind you, we are projecting savings of 5 cents per share in 2004 and between 20 to 25 cents per share in 2005 resulting from this important initiative.

Advate, our next generation recombinant factor 8 product generated sales of $85 million for the quarter. We now expect Advate sales to exceed $250 million for the full year, which as you know is at the higher end of the range that we had earlier communicated.

Finally, significant progress was made during the third quarter on building Baxter's senior leadership team with a number of important senior line management appointments. In summary, we're pleased with the progress that is being made. That is not to suggest however that we are satisfied. After John has taken you through the specifics of the Q3 financial results then I would like to come back to spend a few minutes discussing where our time and attention will be spent going forward but first let me turn it over to John. John?

Thanks, Bob. Good morning, everybody. As Bob mentioned we are making good progress and in addition to meeting our guidance for third quarter I am pleased with the improved quality of our overall earnings and cash flow. Now I'd like to take you to the details of the quarter. Let me start with sales.

Total sales are $2.3 billion, an increase of 5 percent over the prior year, 3 points of which were from currency and as Bob mentioned this is in line with our third-quarter guidance of 5 to 7 percent. Organically sales grew 2 percent, which was slightly below our Q3 guidance of 3 to 5 percent due to more conservative inventory levels held by wholesalers primarily in the anesthesia business. Domestically sales increased 3 percent in the quarter while international sales growth was 6 points. International sales excluding the impact from currency were flat as strongly recombinant sales were offset by lower plasma and vaccine sales.

Turning to our individual businesses and med delivery, sales were $986 million, an increase of 4 percent over the third-quarter last year and organically sales grew 2 percent for the quarter. Geographically U.S. sales increased 3 points and international sales increased 6 points including 5 percent concurrency. In fusion system sales increased 16 percent with strong growth of resulted easier comps to the prior year when Premier hospitals delayed hardware purchases in anticipation of the new contract award.

In our drug delivery business sales were $186 million, an increase of 6 percent, including a 1 point benefit from currency. And despite a lower growth rate in Q3 we continue to expect drug delivery sales to accelerate in the fourth quarter with full-year growth exceeding 10 percent.

Anesthesia sales of 196 million were flat to the prior year as a result of access by wholesalers to reduce inventory levels as we mentioned previously. And lastly, IV sales were 275 million flat to the prior year and down 3 points organically.

In our renal business sales were 485 million, an increase of 8 percentage points including 4 points from currency and sales here in the U.S. increased 4 points while international sales were up 8 percent including 4 points from currency. Looking at our 2 major therapy areas in the renal business, our peritoneal dialysis therapy sales increased 7 percent in the quarter including currency which accounted for 3 points of the growth while our hemodialysis therapy sales were up 15 percent including 7 points in currency with the increase being largely due to stronger dialyzer sales in the United States.

In our BioScience business sales are 849 million, an increase of 4 points and on an organic basis, sales for the quarter were flat. Transfusion therapy sales declined 9 percent on an organic basis for the quarter and organic sales for our core BioScience business excluding transfusion therapies increased 2 percent driven by stronger recombinant sales that were partially offset by lower plasma and vaccine sales, as expected.

In the U.S., sales increased 3 percent while international sales increased 4 percent and on an organic basis international sales declined 3 percentage points due to lower plasma sales and vaccine sales, as expected. Plasma sales increased 1 percent to 254 million for the quarter and on an organic basis plasma sales declined 2 points primarily due to lower sales of international albumin and plasma derived factor E (ph).

Antibody therapy sales are $82 million, an increase of 6 points with organic sales up 4 percent and as you know with the result of the stabilization within the plasma industry, IGIV pricing in the U.S. has continued to improve sequentially throughout 2004.

In the recombinant business including the benefit of currency, sales were at $341 million, an increase of 21 million or 7 percent from the second quarter and up 17 percent compared to last year. Sales growth for recombinant products were 13 percent excluding currency. As Bob mentioned earlier, our recombinant sales included $85 million of Advate, an increase of $34 million for the second quarter as a result of accelerated conversion in both the U.S. and Europe, which now accounts for more than 50 percent of our Advate sales. As a result of the actions we took in the second quarter to reduce the price premium in the U.S. and given the successful launch of Advate in Europe, Advate now represents approximately 25 percent of our total recombinant sales for the third quarter, up from 9 percent of our total recombinant sales in the first quarter of this year. And as Bob alluded to earlier, given our strong Advate sales to date, we now expect sales for the full year to exceed $250 million.

Turning to our gross margin performance for the Company overall, our margin in the third quarter was 41.5 percent and while the margin improved sequentially, it is down 2.2 points from last year's third quarter. This decline is due to our hedging activities, which, as in previous quarters this year, reduced our gross margin by a full point. And in addition improved recombinant margins for the quarter were more than offset by reduced margins in transfusion therapies and lower margins in Medication Delivery as a result of the renegotiated Premier agreement and consistent with what we have seen in the last couple of quarters.

In SG&A for the quarter, spending was $462 million representing a sequential decline from the second quarter of approximately $15 million. And as a percentage of sales SG&A was 19.9 percent of sales in Q3, also down sequentially versus the second quarter and comparable to the third quarter of last year. Increase in SG&A compared to last year's third quarter was largely driven by foreign currency and increased pension and other benefit costs, which were partially offset by our restructuring savings.

R&D for the quarter totaled $124 million, a decline of 9 percent compared to last year and down slightly from the second quarter. As Bob mentioned last quarter, we continued to reevaluate our R&D spending across the Company and as he also commented in July, we expect spending in the second half of this year to be comparable to the first half of 2004, which is reflected in our third-quarter spending. The reduction this quarter compared to last year is due to the termination of our investment in the hemoglobin therapeutics program as part of our restructuring and R&D prioritization efforts last year as well as a decline in spending on the intercept red blood cell program, which is on hold as you know.

In terms of specific milestone achievements for the quarter, we received reimbursement approval for Advate in France, our second largest market in Europe, and we also received regulatory approval to extend the dating of Advate bulk and finished inventory in the U.S. and in Europe. Also during the quarter we filed for approval of our next generation liquid IGIV in Europe following the second quarter U.S. filing for that product.

Lastly many of you have asked us about the progress we're making with our influenza vaccine in light of the recent news regarding the shortage. Just to give you an update there, we are currently in the process of completing the validation of our newly constructed production facility in the Czech Republic where we're working toward producing sufficient quantities of our influenza vaccine to complete the necessary European clinical trials for licensure. We expect the file for approval in Europe and begin Phase III clinical trials in the U.S. during 2005.

Looking at our operating margin overall, this has improved sequentially throughout the year, increasing from 13.2 percent in the first quarter to 16.3 percent here in the third quarter as a result of our gross margin improvement, controlled spending, and our restructuring initiatives.

Just a quick update on our restructuring actions. As we have discussed previously, we have taken a number of initiatives to reduce our overall cost structure and are expected to drive sustainable improvements in our future financial performance as a result of these initiatives. I am pleased to report that we have successfully completed the 2003 restructuring program and we are on track with our 2004 restructuring actions and continue to expect to deliver savings of 5 cents per share this year.

Brief progress to date on individual 2004 restructuring actions include the following. Through the third quarter we have closed the majority of the planned plasma collection centers and have reduced our plasma fractionation throughput to 2.6 million liters, as we expected. In addition, through the end the third quarter 1400 physicians or approximately 35 percent of the 4000 physicians associated with the restructuring announced last quarter have been eliminated. By the end of 2004 we expect more than 50 percent of the total physicians identified to have been eliminated. Thus consistent with our previous expectations, we continue to expect savings in 2005 to be approximately 20 to 25 cents per share, which is an incremental 15 to 20 cents over our 2004 savings.

Turning to cash flow, cash flow from operations for the nine-month period totaled $529 million this year, compared to 670 million last year. This year's cash flow is after funding 231 million for restructuring payments and pension contributions, while in 2003 these 2 items consumed $49 million in the comparable period. Thus excluding the incremental funding for restructuring and pension contributions incurred during 2004, cash flow from operations improved $41 million compared to the nine-month period last year.

In addition, year-to-date capital spending of $363 million is down by more than $200 million compared to the prior year as a result of our efforts to more tightly manage capital spending. And capital spending this year is substantially below the level that we have seen in the last several years.

In terms of working capital, our accounts receivable securitization has also been reduced this year, which has reduced our year-to-date cash flow by $87 million compared to 2003. As a result, the quality of our cash flow is clearly improving. We also continue to see improvements in inventory, which declined for the quarter and increased only $44 million year-to-date, compared to an increase of 233 million last year. This improvement again is driven by the plasma inventory reduction, which is now approximately $170 million over the past 12 months.

Also consistent with our focus on debt reduction, net debt has declined $100 million during the third quarter to $3.7 billion, while our debt to cap ratio of 38.8 percent as of September 30 declined from 41.8 at June 30 and from 42.9 percent last September. This calculation, just to remind everybody, gives 70 percent equity credit to our equity unit debt security which was issued in 2002.

So I am pleased with our progress here but I also recognize we've got a lot of work to do and a lot of work ahead of us to continue to enhance our financial vitality, and we remain very disciplined and focused on the needs for our cash flow improvements.

Before I turn the call back to Bob, I would like to address 2 issues that we committed to discuss with you today at our last quarterly conference call, those being net investment hedges and our pension assumptions. As you are aware we having a net investment hedged portfolio which has generated a marked-to-market loss of $956 million as of September 30, 2004. During the quarter we reevaluated our investment hedging strategy and we will be making the following changes.

First, we will be reducing the level of net investment hedges utilized in the future as this current portfolio matures. At this time, we do not intend to continue the previous practice of rolling over the hedges as they mature. Secondly, we have also decided to substantially reduce the level of financial risk and uncertainty associated with the existing net investment hedged portfolio. We are in the process of entering into offsetting hedges for approximately 50 percent of the existing portfolio, which will effectively lock in 50 percent of the existing $956 million loss. We do not intend at this time to accelerate the maturity of our existing hedges including the liabilities which have been fixed through this offsetting hedge strategy.

Even though the existing hedges are effective hedges for our European net asset position, we believe it is prudent to reduce the risk attached to the existing portfolio while at the same time maintaining flexibility with respect to the timing of cash flows required to settle the losses.

Lastly we intend to settle the losses of $338 million associated with the hedges that mature next year in 2005, out of our expected free cash flow. The remaining hedges that come due in 2007 to 2009 will be settled as scheduled or sooner, as our cash flow allows. The decision to fix a portion of the existing hedge loss and to settle the hedges as they mature will have a negative impact on our net income. For 2005 we expect to incur an increase in interest expense of approximately $15 million, but we believe this higher expense is an appropriate and conservative trade-off in order to reduce the risk going forward.

With respect to pensions, our pension accrue (ph) at year is September 30 and at that date we reviewed our pension assumptions, specifically the rate of return assumption on our U.S. pension fund assets. For calendar year 2004, just to remind everybody, this assumption was 10 percent. For 2005 as a result of anticipated changes to our pension fund asset allocation mix, we will be lowering the pension fund rate of return assumption to 8.5 percent. We believe this is an appropriate level for 2005; however reducing the assumption to 8.5 percent will increase our pension expense next year by approximately $25 million.

In addition, the FAS 87 pension discount rate assumption has been reset as of September 30 and based on the relative interest rate as of that date our 2005 pension discount rate assumption will be 5.75 compared to 6 percent for 2004. This change will also increase pension expense next year by approximately $12 million.

So in summary we believe the changes to our hedging strategy and to our pension assumptions are appropriate and conservative as we move forward. The total effect of these changes on our 2005 earnings per share relative to this year is expected to be approximately 6 cents per share. And while we will provide overall guidance on 2005 in January, given the significance of these items we felt it was appropriate to address them at this time.

Finally, let me conclude my remarks this morning by providing our outlook for the fourth quarter and for the full year. As you saw in the press release, we expect reported sales growth in the fourth quarter to be flat and we continue to expect earnings per diluted share to be in the range of 54 to 58 cents per share. For the full year we expect sales to be in the 5 to 6 percent range including 3 to 4 points from currency, but specifically by business, we expect organic sales for Medication Delivery and renal to be approximately 3 percent and for BioScience to be approximate 2 percent for the full year.

Excluding the impact of special charges taken in the second quarter, as Bob mentioned earlier we expect earnings per diluted share of $1.66 to $1.70. We also continue to expect to generate cash flow from operations of approximately $1.4 billion for free cash flow, which represents cash flow from operations less capital spending of approximately $750 million.

With that, let me turn it back to Bob.

Thanks, John. Before we move on to Q&A let me spend just a minute or two expanding upon several priorities that I discussed in some detail during last quarter's call. First of all, rebuilding investor credibility. We remain committed to not only consistently achieving the earnings guidance we provide but to provide transparency and I would say in a balanced and conservative approach to financial issues that have historically somewhat clouded our results. Our approach to pension assumptions and the balance sheet asset hedges that John just addressed I think are good examples of this.

Secondly, I mentioned during our Q2 call our focus on re-engineering quality processes in everything that we do. I will tell you this morning I'm very pleased with the progress we are making this regard. Not only in terms of quality and regulatory processes but in business and administrative processes as well. Let me give you an example. We just recently completed our R&D project prioritization process for 2005 which in my view much more effectively rationalizes our R&D spending across our various businesses while providing an opportunity to increase the level of investment for initiatives that will take us into new areas.

Finally, I spoke to you in July about addressing a number of organizational priorities both in terms of structure and also in terms of people. As you know since July, 3 senior line executives have been appointed including Joy Adamson (ph) , who came from the outside as President of BioScience; and two internal appointments, Bruce McGillivray, President of Renal and Jim Utts, President of Baxter Europe. Jim's appointment is I think additionally significant in that this is a new role. Pulling together really for the first time all the commercial and operational activities for the Company in Europe. This will bring additional focus, discipline, and I'm also confident higher quality results to a geography that generates approximately 30 percent of Baxter's global sales.

In addition to these three line appointments that I mentioned, there has also been a number of other changes of the staff and functional head levels that have been made over the last several months. I will tell you that I am very excited about the team that we are in the process of assembling to lead our Company in the years to come.

With these organization and structural changes in place we are now in the process of evaluating our current incentive systems and we're committed to ensuring that our management incentives are appropriately aligned with our financial and business priorities going forward.

Changing gears, I'd like to briefly comment on what is singularly the most important issue for our Company going forward, and that is revenue growth. While our existing businesses as you know have very strong positions relative to the respective markets in which we compete, in fact over 75 percent of our total sales are associated with products or businesses in which we are in fact the market leader. In aggregate they will generate year-to-year revenue growth in the low to mid single digits. While we are committed to grow earnings per share at a faster rate, the fact remains that we must aggressively evaluate new businesses, products, and markets that will enable us to accelerate our topline growth.

Toward that end, as I mentioned on last quarter's call, we have initiated a strategic planning process that will identify and prioritize those new growth initiatives that leveraged existing Baxter strengths. Already emerging from that process are opportunities resident in our existing product portfolio that have historically been sub-optimized. We have through this process identified a number of what we have come to refer as breakout opportunities that require additional investment today either in R&D or in sales and promotion. As we complete our financial planning process for 2005, these breakout opportunities will command incremental both investment and focus.

It is our current plan to hold an investors conference sometime in early 2005. At that time we will look forward to discussing with you in greater detail a number of these initiatives as well as further definition and direction on where we plan on taking our Company in the years ahead. In the meantime, we remain committed to ensuring our Company is on track to achieve critical financial and operational milestones.

Before closing I'd like to comment briefly on 2005. As discussed previously we will be in a position to provide specific 2005 guidance at our Q4 call in January. We are as you know currently heavily engaged in our financial planning process for 2005. The benefits that would be derived from our restructuring initiative provide the opportunity to balance earnings increases and reinvestment in the business. We are in the process of determining that proper balance right now.

Having said that, we are committed to delivering earnings per share increases in 2005 versus 2004 while ensuring we accelerate investment in our breakout opportunities and other attractive opportunities that emerge from our strategic planning process and we look forward to providing more specifics in that regard in January.

So with that, we will close our formal comments and we will open up the lines for questions that you might have.

(OPERATOR INSTRUCTIONS) Rick Wise from Bear Stearns.

Good morning, Bob. A couple of questions. First international seemed particularly weak at least relative to my expectations this quarter and I would have thought that international might have been even better with the Advate launch. Can you give us a little more color of what's going on there and how we should think about trends going forward?

We were pleased obviously with the results of Advate but there were other dynamics in the business. I'll let John comment briefly on some of the other dynamics.

A couple of specifics, Rick. International recombinant sales, as you may have seen, were up 38 percent for the quarter. This is due to a couple of things. Obviously Advate has enabled us to accelerate the growth for our recombinant business internationally and we also had a relatively weak comparable quarter last year against which this year's sales compared. The negatives internationally were pretty much in the plasma business, which was down about 12 percent largely due as I mentioned in my comments to reductions in plasma derived factor 8 albumin sales and transfusion therapies, where we saw a decline globally, was also down about 11 percent. So the strength expected in the recombinant business we certainly saw internationally driven by Advate and the expected decline in sales in plasma was certainly not a surprise. Second part, Rick?

Two others. First I realize you're not commenting specifically on estimates for next year. I noticed that first call is at $1.90. You're talking about 6 cents hit because of the hedging and pension issues. Should we just in general assume that we should all whatever our best operating number is we should take that 6 cents off or is it something you hope to make up or again how should we think about it? And maybe last and I will move on -- perhaps you could just talk in general, Bob, about do you feel like you have turned over all the rocks at this point and you are confidence that you're standing on solid ground and we're not going to have any more operating surprises from here?

Let me address the last part of your question first. I think we're on pretty solid ground as we continue to work through the issues as we move into 2005. In terms of the 6 cents, which was the aggregate of the 3 specific projected charges that Johnny enumerated, as I said in my comments, the benefits from the restructuring provide us latitude to do a lot of things and I specifically mentioned obviously generating earnings increases which we are committed to do in 2005 versus '04. Reinvest in the business but also address frankly the kinds of items that John mentioned. So as I said, we are still in the process of sorting out how we want to balance those things going forward, but as I said the benefits from the restructuring do in fact provide us with some flexibility I think to achieve multiple objectives in that regard. So beyond that I'm really not going to comment more specifically this morning.

That is very helpful. Thank you very much.

Glenn Reicin from Morgan Stanley.

Two questions. Let me just try to push it at a different angle from Rick's question. In the past you used to say that you can probably achieve double-digit growth out of this business and on an organic basis on the bottom line, mid-single digit topline and then we should look at the restructuring initiatives and any reinvestment and plug into the balance sheet as offsets of the restructuring. Is that still a good way of looking at it?

I think, Glenn that continues to frame the issues pretty well. I will tell you we were a little disappointed that our sales, organic sales growth were not a little stronger in Q3. There's a number of dynamics there, one of which we mentioned in the Q2 call and reiterated today which is to ensure that we position ourselves as we go out the year to have reasonably balanced inventory levels in the distributor and the wholesaler channels, which is important. But having said that, coming back to the discussions we have had before, which is a business that mid-single digit topline growth and on the bottom line at an accelerated pace approaching double digits, and then in terms of results from the ongoing business and then of course as you mentioned, the impact of the restructuring and balancing the other things. So yes, how you framed it continues to be the way we view '05 and beyond.

Very good. Next question, obviously gross margins and inventories are intertwined. John, you mentioned you had $170 million decline in inventory levels from last year but it doesn't seem apparent from the financials that you're seeing that. I assume that that is FX. I would like to know thought whether there were any write-offs of inventory that impacted the gross margin line in the quarter?

Actually, Glenn, FX is hurting us in terms of inventory decline because of a stronger euro. Plasma inventories in Europe are obviously reporting in higher dollars this year than they were last year, so that 170 reduction is net of an FX penalty.

You mean excluding FX penalty?

It's after the FX penalty.

So what would be the pre-FX penalty decline?

I would rather not comment on exactly how much inventory we have in Europe specifically for plasma, but given where the euro is this year compared to last year, assume half of our plasma business is in Europe. There is a 10 percent higher value to that inventory roughly compared to a year ago in dollars.

Okay, so we should see a much greater improvement year-over-year, come the fourth quarter when Euro comparisons are not as bad -- or not as good?

Fourth quarter to fourth, that is conceptually correct, yes. Your second question, were there write-offs, the short answer is no. We did not take any unusual reserves or write-offs on inventory during the third quarter.

Okay, thank you very much.

Ben Andrew from William Blair.

I'm curious about the Medication Delivery performance in the quarter. Can you kind of break that down for us a little bit into some components to understand where we were seeing the weakness? You mentioned Premier, but maybe some granularity there please.

Actually we are in the process of still sorting that out because we were a little mystified as to how soft the actual sales were in Q3 in IV therapies. The first thing you look at obviously is marketshare, which has stabilized; frankly we will probably go out the year with a slight marketshare gain. We know prices have stabilized in basic IV; IV set business subsequent to the implementation of the new Premier agreement early this year. So the remaining variable becomes underlying volume and demand which is really hospital activity and frankly we don't have at this stage access to the data that drives surgical procedures and basic underlying hospital activity, so we are curious to see how that comes in.

We know a small part of the reduction is associated with a field action we took earlier in the year to bring some micro mix (ph) devices back from the marketplace to retrofit some devices. That is only about a $3 million impact on the year-to-year change, so beyond that specific event, we're assuming at this stage most of that has to do with basic underlying hospital activity, but the thing I would emphasize again is that our marketshare is stable to slightly increasing. The pricing in the marketplace overall, the IV, IV set market continues to be stable. Again I emphasize subsequent to the implementation of our new Premier contract earlier this year. So I'm sorry that I can't give you more granularity if you will on that but that is the best we can do at this stage.

Can you comment at least staying on topic a little bit about anesthesia and if you're seeing still good growth there as well as -- are you seeing pump growth or is that tapering off?

Let me address the two different pieces. The pump growth -- John mentioned this in his comment -- last year we had somewhat easier comparisons because of a number of the Premier accounts holding off capital placements until the new contract was in place. Having said that, we continue to hold marketshare in the infusion pump business and we are a leader in a growing market, so that continues to be an attractive business.

On the anesthesia side, a lot of different dynamics there because we have proprietary products such as Suprane and Brevibloc and other products such as Propofol and a generic multi-source anesthetic agents (ph). The important thing I think to point out is that Suprane continues to grow and it is a very attractive product for us -- again our proprietary product -- I don't think we mentioned globally what the sales are there but it is a substantive product for us.

The other thing that impacted us negatively in the quarter on anesthesia products again was this issue of wholesaler inventory levels which applies to a number of our product lines but probably more significantly to anesthesia than any other singular product category.

Ben, this is John. You know we had tough comparables for -- or easy comparables, excuse me, for the infusion business last year. We saw very strong sequential growth, Q2 to Q3 this year in the pump business by 12, 13 percent. So it was a strong quarter.

Okay, thank you.

Mike Weinstein of JP Morgan.

Thank you. We have some questions here. First you didn't provide an on Brazil. I just wanted to double check back on that to make sure that the investigation of the issues there were isolated.

Yes, no news there, Mike.

Perfect. If we think about cash flow next year with the commitment between the dividend which is about 360 million and what you are talking about for the net investment hedges, that is about $700 million of free cash flow that you will tie up there. This year you are talking about generating 750. Are there any other uses of free cash flow that we should be thinking about next year as we model that out?

Nothing unusual, no. Our debt maturity next year is relatively small, less than $200 million, which we obviously will have the ability to refinance any way if we choose to, but no, there is no other -- other than debt reduction planned uses for free cash flow.

Okay, one product update. Have you filed Advate in Japan?

We plan to do that, Mike, in the second half.

In the second half of this year?

Yes.

And then lastly, I did want to maybe give Bob a chance to stand on his commentary about the potential programs that could elevate the Company's growth. If you could give us any insight there as to some of the different areas where you are thinking about --

Maybe I will give an example, but let me just take a step back and define the process. We are moving ahead with our strategic planning process which I would say is primarily focused on what I will call new initiatives; I guess what I have come to describe as the gaps in the light spaces that exist between our existing business units today. But even before the completion of that, we have also internally initiated a process to identify and I coined the term breakout opportunities which are opportunities that reside or exist today within our existing product portfolio that we think to some degree have either suffered from underinvestment or certainly could benefit significantly by incremental investment going ahead, so that is conceptual.

I will give you one example of that in the interest of time. Our drug delivery business, which is largely the collaborations with an array of pharmaceutical companies has grown to be roughly an $800 million business for us on a worldwide basis, growing in double digits, very attractive margins. It involves as I think you know, a contract manufacturing for pharmaceutical partners. Typically however if not proprietary, specialized packaging systems, frozen premix, prefilled syringes, and other innovative secondary -- or packaging systems.

It is interesting to note that as large as this business has become it is associated exclusively with drugs that are marketed today by our pharmaceutical partners. In other words, it's emanated from companies coming to us oftentimes as their products approach patent expiration. They anticipate generic competition and they want to build a fence around in the marketplace and add utility or value to their product through packaging. That is well and good and that is going to continue to be a driver for growth but we need to be more expansive in our interface with pharmaceutical companies including not only large, but small or even startup pharmaceutical companies all the way back into what I would call the value chain all the way to preclinical. And that is an opportunity, I think a great opportunity for our Company to really expand this business where we bring value not only in the form of packaging systems but also formulation technologies where -- and I won't expand in detail this morning -- this is the kind of thing we will talk about at our investors conference next spring, but we have an array of very exciting formulation technologies that can bring utility actually, clinical utility to the drugs or the pharmaceutical themselves in terms of metabolizing the agents and quicker uptake and so on, or sustained release, what have you.

The other thing we have not even really tapped into at this stage is in our BioScience business leveraging what our fairly unique manufacturing capabilities both in biologics manufacturing and recombinant technology where clearly Baxter is one of the leaders in the world. So we have a lot of clubs in our bag so to speak that can be leveraged and not just with companies for products that are commercialized today but all the way back as I say in the value chain. We need to increase our collaboration with drugs that are in preclinical and work with our pharmaceutical partners all the way through the development cycle and to the market launch. And so I can give you a number of other examples of those kinds of things, but that translates the concept that I described into something a little more specific. Does that make sense?

That is very helpful. I do before I drop one just in case no one asks what John made a comment on -- the potential repatriation of $4 billion of earnings that you have overseas.

Sure, Mike. I don't have any specifics to share this morning. We're obviously looking at our options there and that is a tool in our plans going forward to us help of deal with some of these other issues obviously in terms of freeing up some excess cash and putting in place a more effective capital structure. So how much we're actually going to do next year assuming the President signs the bill we will be evaluating between now and the end of the year, but it is definitely an opportunity for us.

Katherine Martinelli from Merrill Lynch.

I just wanted to go into a couple of product specifics, specifically Advate. I know you mentioned over 50 percent of the sales are now from outside the U.S. Can you give us a little bit better sense -- did you see sequential growth in the U.S. Advate market and maybe just some color on how the free trial program went in the U.S. Were you able to see some conversion over 50 percent of those patients stayed on Advate at the end of -- I think it was a six-week free trial?

I will have John comment on that.

We did see strong sequential growth both in Europe and in the U.S. and the free trial has been very successful for us. Of the patients we have surveyed, we have seen the vast majority of them convert to Advate as a permanent product. And I think that is continuing to drive sequential growth here that we are seeing in the U.S.

So U.S. was up sequentially but when you say over 50 percent -- I think it was 85 million of Advate was outside the U.S. -- is that --?

Yes. It is slightly over 50 percent is in Europe for the third quarter, just like it was in the second quarter.

I was trying to reconcile the comments about the recombinant growth having easier comparisons. I thought you were actually facing some tougher comps this quarter because you had a lot of stocking of Advate in the comparable quarter a year ago?

That is correct -- in the U.S. My comments about an easier comp really applied to our international recombinant business.

Just lastly on the antibody therapy side, I think in the second quarter you got a little bit of (ph) changes in the manufacturing process that freed up some product. Was there any of that in this quarter?

No, no additional freed up regulatory driven inventory.

Is that kind of the run rate we should be thinking about that Advate business in terms of what is organic growth for it?

IGIV? Yes, it is.

Actually one last question. On the R&D side which has declined in absolute dollars throughout the year I know you said that you've been reevaluating certain programs but then looking ahead with going into an investment mode for certain opportunities. When do we -- is this kind of the base in terms of you have evaluated programs and this is kind of an absolute dollars the bottom and where we should assume the starts the growth in these levels or could we see this continue to move downward until you fully evaluate some of the R&D programs that had been in existence prior to the management changes?

I would clearly say I would not expect to see our spending levels decline, certainly not significantly from where they are at now. As John mentioned, Katherine, on a year-to-year basis we had 2 projects that 1 what killed and 1 was put on hold in the hemoglobin therapeutics and the intercept red blood cell, which was put on hold, which was a big piece of the year-to-year change. But to expand on the point I made in my formal comments, this clearly is one of the process areas that we are aggressively engaged in reevaluating. I think I made the comment informally in the Q2 call that as strange as this may sound, that if we had a lot of additional money to spend in R&D today I'm not sure that we would spend it until we have; 1 completed our internal corporate strategy and 2, reengineered our prioritization rationalization processes for project management of existing R&D projects. And these are disciplines that need to be enhanced in this Company. We are in the process of doing that. As I mentioned in my formal comments I think we're making great progress in that regard.

Clearly over time we need to increase and significantly increase the level of spending in R&D and we are committed to do that as we have the wherewithal financially to accommodate that down the road, but only after first we've put the necessary disciplines in place. But to anticipate declines in spending further in R&D from current levels, I would not expect additional significant declines, no.

Thank you, that is very helpful.

Matt Dodds with Smith Barney.

First question is for John on the CapEx. It looks like you're running around 500 million so far. I just wanted to get an understanding. Is that the year-end run rate -- the year-end number we should look at? And then you are saying next year is cranks back up to 750?

No, let me clarify, Matt. Sorry. Firstly our fourth quarter is usually our highest capital spending quarter. What we said before about this year's expectations was it will be something less than $650 million and you are right we're obviously trending well below that level as of today. The 750 million reference that I made in my comments was our expected free cash flow this year with 1.4 billion in operating cash flow less 650 in CapEx and we're really focused on delivering this 750 million of cash flow. So CapEx is certainly trending below 650 right now but it will not be as low as $500 million.

One question on BioScience. For transfusion therapies, should we assume that declines here is just lower collection centers on a worldwide basis -- for the whole industry and this is the new run rate?

That is the biggest piece of it, Matt.

So we should it is down in the next 3, 4 quarters until it resets?

I think that is probably fair.

Thank you.

Ted Huber from Wachovia Securities.

Good morning. John, the fourth quarter target of flat reported growth, what kind of currency expectation is there in that?

Probably about 2 points.

Okay, I get that leads to the next question. Maybe just focus on the fourth quarter, that is a further deceleration so you're talking negative 2 percent or so constant currency growth. Why the deceleration? What is really contributing to that?

Primary issue, Ted, is this wholesaler inventory situation which we've commented on before. We had projected declines on a year-to-year basis in Q4 when we had our Q2 conference call, so we are obviously projecting a somewhat modest greater decline in Q4 versus Q3, but it is largely if not exclusively associated with ensuring that we go out the year with what I have termed as reasonable and conservative inventory levels with both the wholesalers as well as distributors. And that is the fundamental driver.

It would be helpful if you could help us get a sense of what your normalized growth is there then. If each point of growth is worth 25 million, if you are negative 2, you are a good $150 million off of a mid single digit growth target. Is that the order of magnitude of destocking we're talking about, $150 million?

The other dynamic besides stocking in Q4 -- keep in mind that we had very difficult comps relative to recombinant last year, which was big. But no, our view relative to the overall growth profile of the portfolio really gets back to the question that Glenn asked earlier and we remain consistent in terms of our view as to the growth potential of our current businesses.

I guess that's where I'm struggling a little bit is connecting the dots of this deceleration in the second half. What looks to be flat to negative organic growth with a mid single digit belief of what you can really do, yet I don't see the pipeline that gets you there in '05. What am I missing there?

Our organic growth for the first half of the year was up 5 to 6 percent, okay? So we're focusing on Q3/Q4. We are specifically talking about a couple of dynamics which are significant which is the stocking level. A week of inventory or 2 weeks of inventory with drug wholesalers and distributors is big dollars. Actuals through as I said Q1 and Q2 were somewhere I think organic growth of what -- 5 to 6 percent? So the first half of the year is 5 to 6 percent. We move into the second half. We want to make sure we go out the year with responsible inventory levels. We have very difficult comps in the fourth quarter because of the recombinant. Our outlook for our business over the long term or on a yearly basis not on a month-to-month or quarter to quarter, remains consistent with what we described earlier.

Lastly, are there any other pipeline things we could talk about that give you a lift as we move into '05, new products?

We can spend time talking about a number of other new products. We submitted as you know registrations for liquid IGIV. We're going to be launching a new dialysis container in Japan next year. As you know that is a big business for us. In the drug delivery area we have a number of collaborations with drug companies which we really don't comment on publicly out of respect to our pharmaceutical partners. The ALYX system which was launched in transfusion therapy has been very well-received in the marketplace. We're very excited about that. We have additional Advate launches as we proceed through the end of this year into next year. Registrations in Canada and pending and upcoming in Japan.

So yes, not to do a detailed new product but we have a number of new products and representing every one of our businesses, which will be helpful in terms of growth for next year. The other thing that we typically don't talk a lot about and concentrate on which I happen to think is one of the highest leveraged variables for growth in a global diversified Company such as ours is geographic growth, not new products but selling more of the products we have in the bag today in new markets. I talked and have spoken earlier about our organization not only in terms of people but restructuring, and one of the things that we are doing going forward is moving toward more of a regional structure internationally. Jim Utts' appointment as President of Baxter Europe is a good example of this. We're looking to do some similar things organizationally in other areas like Latin America and Asia-Pacific, which represents very attractive growth opportunities for many of our products.

So sometimes we tend to take for granted the opportunity a global company has to expand or grow its topline through geographic expansion, and so we have that variable working for us as well as we move into 2005.

Okay, Bob, thanks.

Glen Navarro with Banc of America Securities.

Thanks, two questions, one for Bob. On the last quarterly call you talked a little bit more about acquisitions to help build out the business in the pipeline. Now you're talking a little bit more about internal development. I'm wondering if -- are acquisitions on hold given the pension costs and the hedging costs that will impact the Company in 2005?

I'm glad you asked the question Glen. Let me maybe clarify that because I think my position on this has been pretty consistent. IT is what I have come to term as the portfolio question, what are you focused on buying and what are you focused on selling? I have been pretty clear I think on saying the portfolio question is a back burner issue for this Company until we get our arms around things, get things under control, achieve both our financial and operating objectives, which again as we said in our formal comments we're pleased with the progress we're making in that regard.

I do believe longer-term acquisitions of either companies or products are an essential element of our growth strategy. In many ways that is the power of leveraging the diversified healthcare model, which is what we are. The practical reality is we don't have the financial wherewithal today and in the short-term to be proactive in that regard and frankly even if we did, I think typically companies underestimate the distraction effect and the opportunity costs associated with the efforts that are required to integrate acquisitions, certainly acquisitions of any magnitude. This company has done a lot of acquisitions over the last number of years. It has consumed a lot of resources and in some ways perhaps has lead to us taking our eye off the ball in building value in our core businesses.

So while acquisitions of either products or companies are an essential element of the growth of this diverse healthcare company, over the long-term, certainly in the next I would say 12 to 18 months, I would not expect -- I would indicate to all of you I would not expect that you'll see much activity from us in that regard. So while our lack of activity in the next 12 to 18 months may appear to be inconsistent with our view toward acquisitions going forward, actually I think it is very rational and balanced relative to what our priorities are in the short term versus what we need to do as we move into what I guess I have come to describe as Phase II of the turnaround of our company.

That is very helpful and thanks for the clarification. Just a separate question on Advate. I'm wondering if you can provide us with pricing per unit here in the third quarter versus second quarter and I'm wondering particularly in the U.S. if pricing had anything to do with the sequential uptick in sales. And then also are you cannibalizing any of your own Recombinate sales to get Advate?

The answer is yes. Frankly most of our Advate sales are in fact conversion from the Recombinate but again, when we convert from Recombinate to Advate, as you know we do it at a higher price. I will come back and John can expand on the price question. We do it at a higher price and a lower cost so there is a margin improvement. The other thing I would comment on is we are in fact gaining overall market share with our success with Advate. It is somewhat greater in Europe than it is the U.S. largely because our overall market share is lower in Europe. It is around 50 percent versus 70 percent in the U.S., so we are encouraged by market share gains we're making. Obviously the conversion from Recombinate to Advate is at a higher price and lower cost but the majority of our sales are emanating from conversion from Recombinate.

In terms of price, the price issue we are not real specific here but I think pricing actions and you know before I came on the scene and John was involved in the business then, we had different approaches to the price premium and I think now we have it about right. We're getting a modest single digit low to mid single digit kind of price premium in the U.S. and I think that is a good balance between insuring we get a premium on one hand on the other hand insuring we would facilitate conversions. We're getting comparable kinds of price premiums in Europe as well. Does that answer the question?

Thank you, very helpful.

Robert Goldman from Buckingham Research.

Thanks, good morning. I've got two questions if I can. The first one is easy. This morning TKT announced that they prevailed in the House of Lords against Amgen on EPO and I'm wondering if that at all plays into your timing in introducing your erythropoietin in Western Europe?

I hadn't seen that this morning so not having seen it, it would be tough for us to comment on exactly how that would impact our program, Robert. But as soon as we are done with this call, I will go look it up and see.

Let me ask the slightly more difficult one. It puts together some of the answers from previous questions. I just want to make sure that I've got it right. That you believe that you uncovered what there is to uncover, that the core growth of your business is mid single digit sales and approaching double-digit on earnings. You do have next year incremental gains from restructuring of 15 to 20 offset by 6 cents of the FX and hedging charges that you mentioned, which nets out deposit of 10, some of which you might choose to invest in incremental R&D, but whatever amount if any of that incremental 10 cents goes to the bottom line would be in addition to the close to 10 percent earnings growth that you think the business can generate. Do I have it right?

You're trying to anticipate our Q4 call, Robert. Those are the major elements of it. The only thing I would add to what you say its not only investment in R&D but investment in sales and promotion too. I think we have markets around the world with a number of our core franchise businesses, renal being an example of that, that would benefit from additional sales and promotion and marketing efforts. So that is the other variable in the equation.

Okay, thanks a lot.

Larry Keusch from Goldman Sachs.

Just a couple of quick once, if I could, and I will just rattle them off and, Bob, you can answer them in any way you'd like. First I am wondering if you could just give us the actual number for your plasma inventories now. Second, just any update on the Thousand Oaks shutdown, where that might be, how long it might take, etc. And then lastly, just any comments around competition in IGIV in the U.S. I guess there are some smaller players potentially entering the market and any observations that you might have there. I know you said pricing has been sequentially up but more from a competitive standpoint.

I think we're up and running, aren't we -- from the shutdown?

Yes. So the Thousand Oaks shutdown is now up and running so that is an easy one. John, why don't you comment on the plasma inventory?

Plasma inventory is roughly where it was at the end of the second quarter. It is up slightly but that is a result of some sales trends, but it is pretty much where it was at the end the second quarter. (multiple speakers) plasma competitors, nothing has changed Larry, from what our expectations were. CSL (ph) has obviously taken some actions and the activities of Riffles (ph) and Ocotpharma are as we expected, so our view towards the U.S. IGIV market continues to be very healthy and on an improving trend.

Just one last one, just relative to -- I know this is getting out in time but just thinking about the cash flows here, etc. 2006, the convert that hits out there, are you still planning to just let that go?

We have not finalized our plan there, Larry. Obviously that gives us some options to deal with at that point in time in terms of what we do with the proceeds, so when we have that been nailed down specifically, we will obviously talk about that.

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