百特醫療 (BAX) 2005 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to Baxter International's third-quarter earnings conference call. Your lines will remain in a listen-only mode until the question-and-answer segment of today's call. (OPERATOR INSTRUCTIONS). This call is being recorded by Baxter and is copyrighted material. It cannot be recorded or rebroadcast without Baxter's permission. If you have any objections please disconnect at this time. I would now like to turn the call over to Ms. Mary Kay Ladone, Vice President Investor Relations at Baxter International. Miss Ladone, you may begin.

Good morning and welcome to our Q3 2005 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, new product development and regulatory matters, contain forward-looking statements that involve risks and uncertainties and of course our actual results could differ materially from our current expectations. Please refer to today's press release and our SEC filings for more detail concerning factors that could cause actual results to differ materially.

In addition, in today's call non-GAAP financial measures will be used to help investors understand Baxter's ongoing business performance. These measures include gross profit, SG&A, operating profit, sundry and earnings per diluted share, each excluding special charges. A reconciliation of the non-GAAP financial measures being discussed today to the comparable GAAP financial measure is included in our earnings release issued this morning and available on our website. Now I'd like to turn the call over to Bob Parkinson.

Thanks, Mary Kay. Good morning, everybody. We're pleased this morning to be able to report solid operating results for the third quarter including, as you know, a continuing strengthening of cash flow. Clearly our major challenge continues to be the situation with the COLLEAGUE pump, and I'm going to spend some time after John's comments to address where we're at in some detail right before we open up the call to Q&A.

All of the results for the third quarter either achieved or actually exceeded earlier expectations and we continue to build momentum with virtually all key financial and operating objectives. The quality of our earnings as reflected by gross margins and operating margins continues to improve. And this is the third consecutive quarter that the Company has generated year-over-year improvements on both of these measures. Our increased operating and financial discipline have been instrumental in driving cash flow from continuing operations to higher levels than earlier projected, and again John will provide more specifics a little bit later.

I think most encouragingly our momentum continues to build with the acceleration of internal R&D and business development initiatives. Let me spend just a minute summarizing a number of the key product launches or R&D milestones, new business development activities and so on that transpired during the third quarter.

First of all, as you noted earlier, we announced two collaborative research agreements with Nektar Therapeutics and Lipoxen Technologies. Both of these collaborations focus on further advancing Advate with the objective of reducing the frequency of injections and enhancing the quality of life for hemophilia patients.

Second, the FDA recently granted approval for the use of a second source of plasma to be used in the manufacturing of ARALAST, a therapy for patients with Alpha-1 antitrypsin deficiency which can lead to hereditary emphysema. This approval allows us to increase the supply of ARALAST in this growing market until we receive approval for the self manufacturing at our plant in Vienna, Austria sometime we would estimate in the next 18 to 24 months.

Also in September we launched GAMMAGARD Liquid in the U.S. and we continue to expect approval and market launch in Europe sometime in early 2006. Also in the third quarter we received FDA approval for FLEXBUMIN, the first preparation of human albumin to be packaged in a flexible container.

And we also receive approval for the first and only frozen premixed Ceftriaxone, the generic version of Roche's Rocephin. Both of these products utilize Baxter's proprietary Galaxy manufacturing process and flexible container system. Galaxy, as you probably know, employs barrier technology, a continuous aseptic filling process, which uniquely positions us in the marketplace with enhanced packaging alternatives that provide added convenience for our customers.

And finally, we recently announced a favorable ruling by the District Court for the Northern District of Illinois that Baxter's generic version of sevoflurane did not infringe on Abbott Laboratories' patent related to sevoflurane combined with water.

These milestones and a number of others illustrate I think the momentum that's building in our R&D programs and business development initiatives and we certainly look forward to providing you with continued updates on the progress in these areas in future investor calls. All in all I would say we're quite pleased with the progress that we are making on most fronts and I'm going to let John now get into some of the detail. John, if you would.

Good morning, everybody. Before providing our outlook for the fourth quarter I'd like to start this morning by reviewing the charges we recorded in Q3, which are reflected in our GAAP results, and then discuss our adjusted earnings. I'd just like to refer you to page 9 of our press release which reconciles our GAAP earnings to our adjusted earnings. Let me start with our repatriation tax charge.

In the quarter we recorded a charge of $163 million or $0.26 per share related to our plans to repatriate approximately $2 billion in unremitted foreign earnings under the American Jobs Creation Act. The repatriation will consist of proceeds from our recent $500 million debt offering, offshore cash and proceeds drawn from our existing European credit facility. This has provided us with considerable financial flexibility and, as we previously communicated, proceeds from the repatriation are intended to be used to reduce debt, fund contributions to our U.S. pension plan and for other capital investments.

Specifically we have initiated the redemption of our 5.25 notes in the amount of approximately $500 million currently due in 2007. Later this year we will repurchase a portion of the Senior Notes associated with our equity unit security as part of the upcoming remarketing and make additional contributions to our pension fund. These actions together with our $1.25 billion equity offering in the first quarter of next year will enable us to significantly strengthen our balance sheet.

In addition to the tax charge, our third-quarter GAAP results include an after-tax charge of $20 million or $0.03 per share related to our announcement last quarter to cease the manufacturing of hemodialysis instruments in our Tampa, Florida facility. You may recall, we also concurrently announced an agreement to exclusively distribute Gambro's HD instruments.

Lastly, during the quarter we also recorded a $5 million pretax benefit from the reversal of previously established restructuring reserves which we will continue to adjust as appropriate as our restructuring program comes to an end.

So to summarize, our GAAP earnings for the quarter were $0.18 a share excluding the charges and the restructuring benefit that I just reviewed which in aggregate totaled $0.29 per diluted share. Third-quarter EPS on an adjusted basis was $0.47, a 12% increase over last year and consistent with our guidance of $0.45 to $0.47.

Let me walk you through the adjusted results which, again, you can find on page 8 of today's press release. First, worldwide sales were approximately $2.4 billion, an increase of about 3% over the prior year, 1 point of which was from currency. Contributing to the growth in the third quarter was the strong performance of the bioscience business where we saw sales growth in the double digits for the third consecutive quarter.

Offsetting strong growth in bioscience was the impact of the COLLEAGUE infusion pump hold, the RTS divestiture in Asia earlier this year, as well as the impact of the U.S. government biodefense order that occurred in Q3 last year. Excluding these items sales increased approximately 7%.

Geographically sales here in the U.S. declined from the prior year while international sales increased 9% including 3 points from currency. Our U.S. sales growth is down over the prior year primarily as a result of the expected reduction in COLLEAGUE sales which were zero this quarter and totaled $60 million in the third quarter last year. Global COLLEAGUE sales last year in Q3 were approximately $65 billion.

Turning to sales by business, medication delivery sales were down 3% to about $957 million. And in terms of specific product categories within medication delivery, our infusion system sales declined 26% as a result of the sales hold on COLLEAGUE while IV therapy sales of approximately $300 million increased 9% with currency contributing 2 points of growth.

Strong growth in this segment was a result of strength in both our base IV solutions business as well as our nutrition business. Our U.S. sales of our base IV solutions were up 10%, the strongest growth of any quarter this year. Drug delivery sales of $192 million were down 3% due to the impact of generic competition for Rocephin and a tough comp to the prior year with the $10 million biodefense order. Excluding these items drug delivery sales have increased by about 10%.

Finally, anesthesia sales of approximately $260 million were up 4% led by growth of Ceftriaxone and strong growth in Europe of Suprane, one of our proprietary inhaled anesthetics. The impact of an additional competitor for PROPOFOL is trending in line with our original expectations.

In renal, sales were approximately $490 million, an increase of 1 point. Excluding the impact of foreign exchange sales were down about a point. And excluding the impact of, again, the RTS Asia divestiture earlier this year, sales were up approximately 6% for renal. Internationally sales increased 3%, again led by strong PD sales which were up 7 points as a result of continued strong pacing (ph) gains in Latin America, Asia and in Europe.

Bioscience had another very strong quarter with sales of about $950 million, up 12% with currency contributing 1 point of growth. Our transfusion therapies business had sales of approximately $134 million, up 8%, while sales for our core bioscience business were $816 million, an increase of 13% over last year. The recombinant business delivered another solid quarter with sales of $392 million, up 15%. We continue to see accelerated demand for Advate in both the U.S. and in Europe. Advate sales for the quarter totaled $162 million and accounted for more than 50% of our global recombinant factor VIII sales with 70% conversion in Europe and more than 35% conversion in the U.S., both up sequentially from the prior quarter. And we now expect Advate sales for the full year to exceed $600 million.

Turning to the plasma business, antibody therapy sales are up 50% to $123 million for the quarter. Sales growth here was primarily driven by additional IVIG sales as a result of our new plasma procurement agreement with the American Red Cross that became effective on July 1st. We also continue to benefit from improved pricing, particularly for IVIG and from new sales of WinRho, a product we launched in Q2. As Bob mentioned earlier, we did begin shipping our liquid IVIG here in the U.S. late in the third quarter; however, the impact on this quarter's financials was not significant.

Plasma protein sales of $242 million were down 5% compared to the prior year as strong sales of our specialty therapeutics such as Phiba (ph) and Tiseal (ph) were offset by declines in plasma sales to third parties and a loss of contract manufacturing revenue from the American Red Cross. Our biosurgery business had another strong quarter with sales increasing by over 14%.

Looking at gross margins, our adjusted margin in the quarter improved by 1.7 points compared to last year and was comparable to the second quarter at 43.2%. Expansion versus last year was driven primarily by higher margins in bioscience largely the result of Advate conversion, improved IVIG pricing and improved mix.

Looking at our margins overall, year-to-date we have absorbed nearly a half a point of margin pressure from higher raw material and energy prices versus last year and still have improved margins on a year-to-date basis by 1.3 points. As Bob mentioned, this is the third consecutive quarter when we have demonstrated year-over-year improvements in gross margin percentage.

Looking at SG&A, total spending increased about 6% to $490 million for the quarter. Savings achieved, as expected, from our restructuring actions were more than offset by increased pension expense, foreign currency and increased spending in marketing programs specifically in our bioscience business. As a percent to sales, SG&A was approximately 20.4% in Q3 compared to 19.9% last year and down slightly from 20.8% in the second quarter.

We remain on track to complete our restructuring by the end of this year and generate the expected savings related to this program. And as of the end of Q3 we've now eliminated approximately 3,500 of the 4,000 expected positions as planned.

R&D totaled about $133 million for the quarter, up 7% over last year with the growth primarily reflecting accelerated spending in bioscience. So as a result of our strong sales growth and gross margin expansion, our operating margin of 17.3% was comparable to last quarter, however improved a full point compared to last year, again improving over the prior year for the third consecutive quarter.

Interest expense, as expected, totaled about $31 million, an increase of $11 million over last year as a result of both higher interest rates and the impact of our net investment hedge strategy. And our tax rate on a year-to-date basis is now 21.5%, in line with our previous guidance of approximately 22% for the full year. In the third quarter our tax rate was slightly lower than 22% due to the strong European Advate sales and lower domestic taxes due to lower sales of COLLEAGUE pumps due to the hold situation. So to summarize, our adjusted earnings in the quarter were $0.47 per diluted share, in line with our previously issued guidance.

Turning to cash flow, we had another strong quarter. Cash flow from operations totaled $536 million, up from 277 million last year, and on a year-to-date basis cash flow from operations is now $1.3 billion, up nearly $800 million compared to last year. Capital spending for the quarter totaled $116 million and we now expect capital spending for the full year to be approximately $500 million.

Free cash flow of 420 million for the quarter is an improvement of 277 million over last year and as was the case in the first half of the year, the most significant change in our free cash flow is our improved working capital management where we continue to make great progress. DSO of 61 days declined compared to last year by nearly three days and cash flow from our securitization programs has again been reduced with an outflow this quarter of $12 million.

Inventory turns also improved to 2.7 as of the end of Q3 compared to 2.5 last year and plasma inventory, again, declined and is now down over $300 million since its peak two years ago. Net debt of 2.7 billion is $1 billion lower than this time last year and we ended the quarter with a net debt to cap ratio of approximately 25%, a significant reduction compared to over 38% this time last year.

Finally, on our net investment hedges, the net liability as of the end of Q3 is approximately $640 million, a reduction of about $90 million during the quarter, an over $500 million reduction since the end of last year. Thus far this year we have paid off nearly $400 million of the net liability with currency movements accounting for the remaining year-to-date reduction.

So in summary, clearly we've made some great progress here with our working capital management and capital allocation processes over the past year. This together with the consistent operational improvements led by our bioscience business has enabled us to significantly improve our overall financial position over the past 12 months.

Let me conclude my comments here this morning by providing our outlook for the fourth quarter and for the full year 2005. As you saw in today's press release, for the fourth quarter we expect organic sales to decline in the low single digits; this is largely a function of the COLLEAGUE pump hold and the impact of generic competition for PROPOFOL as well as the impact of a second tranche of the U.S. biodefense order. In addition the divestiture of the RTS AIDS business will again impact our fourth-quarter sales growth percentage.

Excluding these items and consistent with previous quarters organic sales growth would be in the low to mid single digits. Adjusted EPS for the fourth quarter excluding charges is expected to be between $0.56 and $0.58 per diluted share. In terms of sales for the full year, we expect organic sales growth to be in the 3 to 4% range and by business we expect organic sales from med delivery to be flat to down -- down slightly as a result of the lost COLLEAGUE sales, lower sales of PROPOFOL and, as mentioned earlier, the tough comps for drug delivery as a result of the U.S. biodefense order.

For renal we expect organic sales to be flat as strong international PD growth is offset by the expected decline in HD due to the divestiture of the RTS renal service business. And finally, we expect bioscience organic sales growth to be up in the mid to high single digits driven by strong recombinant demand and continued penetration of Advate. In addition, we expect increased antibody therapy sales as the result of both improved pricing, the launch of WinRho in the U.S. and the benefit of the American Red Cross agreement effective July 1st.

With respect to margins, due to our continued gross margin expansion, particularly again within bioscience, and accelerated growth in R&D of 5 to 7% expected for the full year, we continue to expect operating margins to improve sequentially in the fourth quarter and to average between 17 and 17.5% for the full year. Therefore on an adjusted basis we expect earnings per diluted share for the full year to be between $1.88 and $1.90.

Our full year guidance does exclude the net $0.26 per diluted share impact from the second- and third-quarter charges as well as any final adjustments to the tax expense for the American Jobs Creation Act dividend. A further charge is expected in connection with our hemodialysis actions as well as any costs associated with early debt retirements and the impact of any charges for additional remediation actions or costs that may be required for the COLLEAGUE pump beyond those taken to date.

For cash flow, we now expect cash flow from operations for the full year to be approximately $1.7 billion. This is up $100 million from our previous guidance of $1.6 billion. We expect free cash flow for the full year of approximately $1.2 billion which is a $200 million increase from our previous guidance. This does exclude the impact of any additional contribution we make to the U.S. pension fund following our American Jobs Creation Act dividend as I mentioned earlier. With that let me now turn the call back over to Bob.

Thanks a lot, John. Despite the financial progress that we're making, clearly our top priority in the Company continues to be the issues associated with the COLLEAGUE pump. As I did in the second quarter call, I'd like to spend just a couple of minutes providing some context for the COLLEAGUE situation.

An area of intense focus for over a year has been the establishment of product improvement programs for all of our medical instruments including COLLEAGUE. Our objective has been to improve the performance and reliability of complex products that incorporate mechanical, electronic and software components and products that are subject to different requirements in their design and in fact their use when compared to disposable medical products.

This product improvement effort led us to initiating a number of voluntary field corrective actions on COLLEAGUE and to ultimately place the product on hold. Over the last several months, as you know, the FDA has gone back and classified three of our field corrective actions as Class 1 recalls and last week, again which I'm sure you know, the agency came to our facilities here in Northern Illinois and took action to secure the product.

Now the questions I know that you have are, first of all, when will we begin remediation efforts on the installed base of COLLEAGUEs in the field; and second, when might we be in a position to begin shipping new devices again and especially in view of the actions taken by the agency last week?

Let me first of all state that our most important priorities are the patients and hospitals who depend on this product. Obviously we're not pleased that they are being inconvenienced by these issues and we're working diligently to cooperate with the FDA to resolve them. Having said that, we're prepared to repair the pumps in the field pending FDA's review and agreement to proceed. But until we've satisfactorily addressed the Agency's questions and concerns we're simply not in the position to talk about a specific date at this point when repairs might begin.

What I can tell you is this, we certainly intend to fully cooperate with the FDA and we will repair the pumps as quickly as possible. It's also premature given that I think to speculate when we might be in a position to begin shipping COLLEAGUEs in the U.S.

While we'd like to provide additional clarity on this, our first priority is to complete the remediation effort on the installed base of devices. We'll be working with the FDA on the timing of that effort and we'll also work with the FDA on how we deal with hospitals requiring additional devices in the meantime. Unfortunately, again, we can't provide further definition to that this morning.

The most important thing I think for you all to know is that every effort is being made within the Company to address these issues as soon and as effectively as possible. No expense or resource is being spared in our efforts and there's not a day that goes by that I personally don't spend time to some degree involved in the COLLEAGUE situation. Our commitment first and foremost is to the patients and to the hospitals that use COLLEAGUE and we're also committed to working collaboratively with the FDA to define a roadmap for proceeding ahead as quickly as possible.

Obviously I'd be happy to discuss this matter in more detail during the Q&A this morning. So I think at this point what we'll do is just open up the call for questions. Mary Kay?

Cindy?

(OPERATOR INSTRUCTIONS). Rick Wise, Bear Stearns.

Good morning, everybody. Let me follow-up on your COLLEAGUE comments, Bob. Just from my limited perspective, the FDA seizure of the inventory seems like a highly publicized move seeming to somehow represent a step-up in their discomfort or dissatisfaction, whatever the right words are, and therefore it's likely to take longer to resolve all these issues. How should we be thinking about it? Again, I know it's awkward to talk about but how should we be thinking about that issue? Is it now more complicated than it was and any indication as to when some dialogue or productive dialogue might get underway?

There are several questions you incorporated in there, Rick. Let me see if I can address them one at a time. First of all, I'm really not going to comment or speculate in terms of the motives of the Agency specifically, I think that would be inappropriate to do that. On the other hand, I think it's fair any time there's an action like this to characterize it as an escalation in the attention and scrutiny by the Agency on this issue is absolutely the case. So I don't think you can deny that.

Relative to going forward what this translates into, unfortunately I really can't provide a lot more definition than what I alluded to in my prepared comments this morning. I mean, overall our relationship with the Agency is very good. We deal with the Agency on a wide variety of issues and obviously respect and appreciate what they do and we're making every effort to work collaboratively with the staff.

Having said that, clearly there's issues with COLLEAGUE. The reality is there's some history here with this product going back to warning letters that were issued on this in 1999 and 2001 which is one of the reasons not long after I came on board we launched these product improvement programs to really get at the heart of the issue to make sure that we could do what's necessary for the product.

I think one thing that's important for everybody to understand is that the issues related to COLLEAGUE are not what I would describe as traditional manufacturing quality issues per se, but have more to do with various design parameters as well as certain internal quality systems. And we've done -- I didn't enumerate in a lot of detail in my prepared comments, but we've effectively put new product development on other new products on hold to ensure that the right engineering and R&D resources are dedicated to COLLEAGUE. We significantly increased the overall resources as well dedicated to this. We brought in engineering technical talent from outside. I basically told the organization going back in time you've got a blank check to deal with this as necessary.

But the kind of issues we're dealing with here take some time. So I'm probably telling you more than you need to know at this point, Rick. And I wish that we were in a position to say here's the date, here's the date, here's the date. But until we work through the specifics with the Agency, I don't want to speculate and I certainly don't want to be presumptuous and obviously as more definitive insight on this whole issue evolves we obviously will communicate that.

Two quick follow-ups. Can you provide -- on a separate issue, can you provide some color on what the contribution to sales or impact on sales and margins might be from a couple of new products like FLEXBUMIN and IVIG? Just help us put that in perspective. And last, Bob, just a broader question for you. How do we think about '06? It's too early to give guidance but is it -- further your investment, an acceleration? Again, for the margin improvement, how should we be framing it in our minds? Thanks so much.

Let me address the second part, Rick, and then I'll let John respond to the first part. Obviously we're not going to provide guidance for '06 until after the first of the year, you know that. But in terms of framing various dynamics I think the evolving trends of improved quality in our P&L we certainly would anticipate are going to continue. I think we can expect continued favorable byproducts -- a byproduct of the focus on working capital and management of cash flow.

I'm encouraged that we reported R&D increase of 7% in the third quarter. I think you can expect that rate to perhaps even increase at a higher rate in the fourth quarter. And I'm hopeful that that's a trend that will continue into next year as we work through some of our internal R&D prioritization as well as process disciplines and so on. We need to spend more on R&D going forward and I think we'll do that.

The other thing that continues to gain momentum, which we'll be talking more about certainly as time goes by, is increased traction on various business development initiatives in all of our businesses. So beyond that, that's kind of how I would color '06 at this point without being too specific. So John, I'll let you address the first question.

Sure. Just a couple of quick comments on your question, specifically FLEXBUMIN and IVIG. I'll add the American Red Cross in there as well. All of those are going to have a pretty significant impact on our overall plasma therapeutic business. Flex Albumin is a product that will be the only supplier in the market with a plastic container which has obvious ease-of-use and convenience features for the users and we expect to have that product priced appropriately so there will be some benefit to that clearly.

In terms of IVIG, between the American Red Cross plasma product that we're now purchasing and our liquid launch here in the U.S. this year and Europe next year, IVIG for us is going to be over a $0.5 billion product category. So that's a significant increase from where it has been tracking. So all three of those are pretty significant improvements to our overall plasma and bioscience business.

Thanks so much.

Glenn Reicin, Morgan Stanley.

One question for Bob, two for John and hopefully I'm not cheating too much here. With respect to COLLEAGUE -- and I don't want to spend too much time on this -- can you characterize the fix that you did have in place that you had not presented to the FDA prior to the seizure? Was it a comprehensive fix from a design point of view or was it just a temporary fix? And can you just characterize the tone of dialogue in the last six days and whether they agree with your assessment that you're being constructive here?

And then for John, can you tell us a little bit about SG&A? You've had a lot of spend in the third quarter, how much of that is over your original plan that you had earlier in the year? So how much can we characterize that as being discretionary? And then any thoughts on what you're going to do with all the cash next year?

You have any more questions than that?

I thought those were good ones.

All right. Let me address the COLLEAGUE questions, Glenn, and then John can address the other ones. And I don't want to get into too much detail here this morning because when we talk about fixes, that's an absolute term in many ways. Let me break down some components here for you. The Y2A crystal issue that we talked about on the second-quarter call, we do have a fix for that -- a technical fix for that. The first thing you do is you have to come up with a fix, the second thing you have to do is validate that. We have validated that and we are dialoguing with the Agency specifically on the Y2A crystal fix.

There are other what I'll call product improvements that are really associated with what I guess I'd just characterize as next generation software, if you will. And a piece of this gets to some of the issues associated with battery use and the discharge issues on the battery that was included as part of the last communiqué and the last Class 1 recall.

We have not yet completed the validation of what we refer to as the Vista (ph) balance software so we have a little bit of work to do there. I would anticipate that we will conclude that shortly and then be in a position to pass that information along to the Agency in addition to the information we've already provided specifically on the Y2A crystal. So I don't want to get into any more detail than that, but those are probably the two biggest components of -- call them fixes or product improvements, however you want to characterize that.

The second part of your question in terms of our relationship with the Agency -- as I said in my comments, we work with every division of the Agency, I would characterize our relationship with the Agency as actually very good. But having said that, in a narrower scope on COLLEAGUE, given the history of this product, which I characterized and described to some degree in my comments and with the continued issues with the three Class 1 recalls and then the later action last week, I think anyone would be naive to assume that they are anything other than very concerned and as are we.

Now how you translate that into characterizing or describing a relationship in the narrow context of COLLEAGUE, I'm not going to try to do that. I would just say again overall that our relationship with the Agency I think it's very positive. But we continue to work in a very constructive way with them on all fronts. With that, John, I'll let you answer the --.

In terms of SG&A for the quarter, unlike last quarter there weren't any unusual one-timers in our SG&A this quarter. Specific to your question, the only unplanned expense in here was some FX impact and accelerated spending for, again as I mentioned in my comments, bioscience particularly. Obviously we're seeing the results of our spending there and the growth of our recombinant and plasma business.

So we did not plan for the additional plasma volume that we're now selling off of our Red Cross plasma procurement contract and that's bringing a little more SG&A with it as well as the marketing dollars that we're putting behind the recombinant business. As you know, year-over-year pension expense is a significant increase this year, roughly $15 to $18 million a quarter.

In terms of cash next year, the good news is we're tracking well in line with where we had hoped to be in terms of improving the balance sheet. As you know, we had quite a few issues to deal with over the past 12 months and the strength of our cash flow has enabled us to do so very effectively and in some ways ahead of schedule. So as we go into next year the balance sheet strengthening that we had hoped to be accomplishing we're very well on track with. Where we deploy either free cash flow next year or improving debt capacity, it's pretty much in line with what we've articulating over the past 12 months.

As we get through the "Phase I" efforts that are under way we will start thinking about either acquisitions or share repurchases. But still for the time being debt reduction is clearly the focus and I included in that category the pension liability as well as the hedge liabilities which we've dealt with this year. And early next year we have additional debt that comes due which we'll deal with and then be more able to think about the growth investments that I just mentioned.

Two quick follow-ups. On the SG&A line should we expect that you're going to leverage that line or are the margin improvements all going to be gross margin driven? And on the use of the cash, when you properly fund the pension is there going to be a benefit on the P&L where you no longer have to amortize the losses or the deficit? Maybe you could talk through the P&L implications of fully funding the pension.

I'll get into that obviously in January with our '06 guidance, Glenn. But as you know, if we do fund as we are planning to do additional monies into the U.S. pension fund there will be an accretive benefit from doing so. How much that is, we'll communicate that probably at the time we do it and may not even wait until January to tell the investment community how much we're putting into the fund, but there definitely will be an accretive benefit of that.

In terms of SG&A we're continuing to manage that tightly, so I wouldn't expect SG&A growth to accelerate beyond what you're seeing this year. So we're still focused, as you know, on dropping margin improvement down to the operating margin line and that's a function of both benefits we achieve from the SG&A spending that we do have as well as operating leverage off of our gross margin growth.

Thank you.

Mike Weinstein, JPMorgan.

I'll try and narrow it down to a couple here. Maybe just if you would, could you try and characterize the 50% improvement in the IGIV line? If you could maybe try and give us a sense of how much of that is from American Red Cross, how much of that is from the liquid launch -- which I assume was small, I think you even said it was small. And I also was hoping to get a sense from you of WinRho and how significant of a product you think that's going to be? Thanks.

Of the 50% improvement for the quarter, about half of it is from the Red Cross. Liquid was fairly immaterial, as I mentioned. The other growth we're seeing is pricing improvement. That's by far the second most significant benefit that we've seen really sequentially over the past four to six quarters. And those two are the largest contributors to the growth that we saw here in Q3. And as I mentioned, going forward IVIG is going to be in excess of a $0.5 billion product for us with those two benefits plus the liquid launch benefit that we'll see at an accelerated pace here in Q4.

WinRho, again we're very pleased with the progress we've got with WinRho here in really the first full quarter of launch. Expectations for that product -- in the foreseeable future in the $40 to $50 million range on a full year basis.

That's very helpful. John, PROPOFOL seems like it probably wasn't hit that much during the quarter; your anesthesia sales were still up 4% which was just better than we were modeling. Maybe we're being too conservative, but maybe just want to give us some more commentary there.

PROPOFOL in total, Mike, as I mentioned, is pretty well in line with our expectations. It is down from our last 12 months run rate of sales by about 35% here in Q3. So we've been able to offset that with some of our multisource generic growth as well as Suprane and Ceftriaxone, but PROPOFOL, we did see a decline from where we've been running over the past four quarters.

Good. And then the last question I'll drop is -- I just want to make sure I understand your strategy and the timing of handling the (indiscernible). You're planning on going out there and remarketing those notes when -- in the fourth quarter?

Yes, the equity unit remarketing is something that's done actually by the bondholders themselves, so they will be remarketing the existing debt security into a new two-year note. What we intend to do is actually repurchase a portion of the existing $1.25 billion notes here in the fourth quarter. That begins in November -- in early November. So there's an obligated date when that remarketing program has to commence. It's in the middle of November -- I forget the exact date, it might be the 11th or 12th. And as part of that, as the current bondholders remarket their existing debt we'll be in the market repurchasing a portion of that and effectively retiring it.

Perfect. Thank you, guys.

Glenn Novarro, Banc of America Securities.

Good morning. I'm wondering if you can talk more broadly about the pump market and your current position in the market. How much of your business is contracted? I'm assuming most of it is. I'm wondering just how easy is it for the competition to come in and take market share given your issues today. And then I'm wondering when you ultimately do come back to the marketplace, should we assume that whether it's 1Q or 2Q next year that you could immediately get right back to the run rate that you were experiencing earlier in the year before the recall? Thanks.

You raised a number of different dimensions there. Let me kind of take a step back and shape this at a high level. As I think you know, our market share in the U.S. for both of our primary -- what I'll call acute care hospital systems which is obviously COLLEAGUE and then FloGard is roughly -- we're roughly 40%, 40% plus of the U.S. market. And I think you also know that roughly 80% of our pump sales reside within the U.S. I mention that because the contracting is a little bit different in markets outside the U.S. than it is in the U.S.

Typically, and I think you know this, the pump sales, both the pumps and the sets and so on are part of really the solution and the Gravity IV set bundle, if you will, that's on a broadbase contract negotiated both at the GPL level but also at the individual hospital level as well. In terms of some of the issues and -- call them I suppose barriers or obstacles or difficulties in conversion, in some ways it has to do with the fact that our system, both COLLEAGUE and FloGard, utilize standard tubing.

In other words, the pumps are designed to work with the standard IV tubing which typically is at a lower price than say our major competitors, Alaris and Hospira, who largely have what I'll call dedicated sets to their particular pumps that are typically priced at a higher level. In addition, the business model is a little bit different. We typically sell the hardware or lease the hardware and the customer buys the sets on a standard contract. Where oftentimes our competitors will place the pumps free of charge and in essence be reimbursed for the hardware through the incremental cost that's associated with the disposable and in their case the captive set.

So it's a little bit apples and oranges in terms of comparing the systems that way. Obviously first and foremost, what we want to do is make sure that the installed base of devices, which is roughly 250,000 devices, about 200,000 in the U.S. -- that we can move ahead as quickly as possible to remediate both the crystal, the software issues and so on and meet the needs of the hospitals.

Obviously it's a concern as we continue to manage through this and our biggest concern, as we've stated before, is to be able to meet the needs of the patients in the hospitals. We don't like putting the hospitals in this position certainly and we're spending a lot of time talking to the hospitals and providing support in whatever way we can.

So there's economic ramifications to the hospitals. There clearly are clinical ramifications. The other characteristic of the market I would tell you, especially in the U.S., is these are complex devices and in the clinical environment today with nursing shortage and nursing turnover and the attendant training that goes along with that for devices that have become increasingly complex over the years, that's really critical from the overall safety and the use of the products.

And so the notion of having mixed systems in the hospital is also somewhat problematic. So I'm going to stop there because I don't want to get into too much detail, but just kind of wanted to give you a sense of some of the basic characteristics that exist primarily in the U.S. market.

Can I ask one follow-up. It sounds like when you do get back to the market you should get back to a run rate that we saw in the past. But are there any major contracts that are coming up soon, specifically on pump or that would be part of -- that pumps would be included? Any contracts coming up in the next couple of months?

Not really. We've had discussions with one GPO right now where we have the IV contract and the pump contract and increasingly a trend is dual sourcing. You know that from renegotiating our premier contract a couple years ago which became dual source. There's some possibility that there would be a dual source on the infusion pumps which I think may very well have happened independent of the issues that were happening with COLLEAGUE. But other than that -- and I don't want to be real specific as to who it is. Other than that, no, there are not an array of contracts that are coming up for either bid or renegotiation.

Okay, great. Thanks, Bob.

Katherine Martinelli, Merrill Lynch.

This is actually Paul Choi (ph) filling in for Katherine. If we could just go back to the COLLEAGUE for a second. How would you characterize -- given what you've just said, given that the hospital budgets are coming to a close this year, how long the COLLEAGUE should stay off until hospitals will have to go to competitors?

I think the issue, Paul, is I think a function of several different things. First of all, you've got hospitals that have pumps that have been in there for a number of years that independent of what we're dealing with right now on COLLEAGUE they'd be looking at upgrading or rolling over those pumps, so that's one dimension. I would say roughly 10 to 15% of our installed base probably rolls over in that fashion every year.

Then you've got the other issue of incremental pumps that are required to meet additional activity or census. Typically what hospitals do is they will have an installed base of devices that accommodates their peak hospital activity level which means at certain times of the year that they have a number of devices that are not in use. Typically hospitals will plan in that fashion, but to the degree that there are certain institutions where hospital activity is increasing or let's say they're expanding, adding beds and so on, then they're going to be faced with unfortunately the decision of either waiting a while to see how things evolve specifically on COLLEAGUE or contemplating considering alternative supplier to the pumps.

Obviously the issue associated with that is the comment that I made earlier in response to Glenn's question which is dual systems and the associated training and complexities that emanate from that which most hospitals clearly want to avoid. So I'm not sure exactly -- the market overall for pumps annually is probably not growing much more than maybe 5% a year or something like that and much of that has to do with replacements, not hospital activity. Because as you know, hospital census and hospital activity has been fairly flat over the recent years and projected to continue. You had a follow-on to that, Paul? I want to make sure I addressed your question.

I think you got it, Bob, thank you. If I could ask John maybe about the tax rate. Given the COLLEAGUE situation, how should we think about it for the next couple quarters?

Our guidance for Q4 assumes a 22% rate.

Then on the R&D -- given most of it is, as you said, being addressed a lot to COLLEAGUE, going forward will that be the run rate we should expect?

I think the growth that you're seeing this year of 5 to 7% is the growth rate that I would expect going forward.

My comment, Paul, relative to focusing R&D and engineering resources on COLLEAGUE obviously is really within the parameters of medication delivery. So that probably overall is not material in corporate R&D spending. It's really redirected within the areas that are involved in instrument manufacturing.

Thank you.

We have time for one more question.

Matthew Dodds, Citigroup.

Sorry, Bob, I'm going back to COLLEAGUE one more time. Since we don't know the exact timing of when it could come back on the market, is it fair to characterize the product as heavily back end loaded in the year so at least in the first half you're not going to see anywhere near the impact you've guided us to in the second half of '05?

Typically -- and I think it was -- I don't know if it was Glenn or Paul previously made the comment about year-end budgets and so on. Typically for capital purchases, as you know, that is in fact the case. You've got capital budgets that are there to be used or sometimes are lost. So we typically see most of our sales of COLLEAGUE in the fourth quarter as we approach the end of the year. So we've obviously reflected that in our guidance for the rest of this year. And then typically as you start a new year the first quarter and the second quarter are always the softest of the year, especially given our model -- business model of really selling hardware.

And then last question. If you decide to launch a generic sevoflurane, can you just comment on the vaporizer situation, how much of an issue that is? If you needed the vaporizers and you decide to launch, how would that ramp throughout 2006?

I really don't want to get into any specific discussion on sevo this morning. Obviously we're pleased with the recent court decision on the patent infringement or lack thereof. You know that we've received U.S. approval, but under a prior arbitration ruling -- I think you're aware of this -- we can't market sevoflurane directly or indirectly until after December 10th. So given that constraint and some of the other things that are going on, I don't really think it's appropriate for me to get into a detailed discussion on the vaporizers, okay? I hope you understand.

I do.

Thanks.

I would like to turn the conference back over to Miss Ladone for closing remarks.

We don't have any closing remarks this morning. Thank you all for joining us.

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