百特醫療 (BAX) 2006 Q3 法說會逐字稿

Good morning, ladies and gentlemen. 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). As a reminder, this call is being recorded by Baxter and is copyrighted material. It cannot be rerecorded or rebroadcast without Baxter's permission. If you have any objections please disconnect at this time. I would now like to turn the call over to Ms. Mary Kay Ladone, Vice President Investor Relations at Baxter International. Ms. Ladone, you may begin.

Thank you, Sean. Good morning and welcome to our third-quarter 2006 earnings conference call. Joining me today are Bob Parkinson, CEO and Chairman of Baxter International and Rob Davis, 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. A reconciliation of the non-GAAP financial measures being discussed today to the comparable GAAP financial measures is included in our earnings release issued this morning and available on our website. Now I would like to turn the call over to Bob Parkinson.

Thanks, Mary Kay. Good morning. We are pleased today to be able to announce very solid results for the third quarter. Our third-quarter results announced earlier this morning I think reflect a continuation of many of the themes that we have talked about over the past two years. And I am pleased that we continue to meet or exceed the expectations that we have established with our investors.

Let me spend just a few minutes reviewing some highlights for the quarter and then I will turn the call over to Rob for a more detailed discussion of the financial results and then after that, Rob, Mary Kay and I will be happy to field any of your questions.

Momentum continued to build at the sales line from previous quarters with sales growth in the third quarter of 7%. Once again led by very strong performance as you saw this morning from BioScience. We continued to make great progress with the profile of our P&L with gross margins improving to 47.5% for the quarter, a 4.3% improvement over Q3 2005 and actually the highest level gross margin percentage since the fourth quarter of 2001.

Now while clearly a big part of that improvement came from the improving dynamics in plasma protein, I think it is important for everyone to understand that each of our businesses is generating improved gross margins from the prior year and this is a reflection of our broad-based initiatives across the Company to build shareholder value through very focused execution.

As we discussed last quarter, R&D spending also continues to accelerate, growing 12% in the quarter from prior year. This is actually the first quarter in three years that R&D has increased more than 10% and as we discussed previously, our improved financial position will allow us to continue to accelerate R&D spending going forward.

Operating income as a percent to sales was 19.7% for the quarter and adjusting for stock option expensing booked in the quarter, operating income was 20.7% to sales. And again Rob will get into the financial results in more detail, but all in all we are extremely pleased with our continued financial progress.

Let me spend just a couple of minutes providing you with an update regarding COLLEAGUE. We have made significant progress in bringing this to both definition and resolution. While as of today, we have not received approval of our corrective action plan from the FDA, I can tell you that the communication and the spirit of cooperation with the FDA is very good. We certainly appreciate the time and attention the agency is dedicating to this issue.

As we have told you previously, this is a very iterative process, which I am confident we are bringing to closure so that we can initiate the remediation efforts. The agency is also working with us to define the parameters within which we can move forward to provide pumps on an urgent need basis to the marketplace.

Having said all of this, we are still not at a point where we can provide a definitive timetable to our U.S. customers as to when we will begin remediation efforts and then of course ultimately be in a position to sell new pumps. We are still planning that we will not sell new devices in the United States in 2006.

In terms of market dynamics, there has been really very little market share shift since we discussed this the last quarter. We disclosed in July that at that point in time I think we had lost about 4% of the channels of our installed base since the product had been put on hold in July of 2005.

Over the last three months, that number has increased to only 4.6% and again to refresh your memory, every percent channel lost equates to roughly $1.5 million in annualized set sales and about $1 million in annualized gross margin. So the impact since Q2 has really been financially immaterial. But as I have said before, the more important issue is to be in a position to serve our customers who have been more than patient throughout.

The news on the international front regarding COLLEAGUE is actually quite positive. We are now selling COLLEAGUE in all key markets outside the United States and are approaching the completion of the remediation of the installed base. These efforts have gone quite smoothly and we have learned a lot that will enable us to execute very efficiently in the U.S. once we have been given the green light to move ahead. Obviously we will be happy to talk about COLLEAGUE in greater detail and address any questions you may have in the Q&A session.

Finally, a want to spend this morning, just a couple of minutes, discussing key business development and R&D highlights for the third quarter. As you know, we announced on October 3 the sale of our Transfusion Therapy business to Texas Pacific Group for $540 million. As previously communicated, we expect the deal to close by Q1 of 2007. This transaction I think reflects our continued focus on optimizing our portfolio thereby enabling us to concentrate both our efforts and our investments on businesses that are more strategically critical to our long-term success.

In the third quarter, we also announced preliminary results from our Phase I/II trials of a whole virus H5N1 influenza candidate vaccine that utilizes our proprietary vero-cell technology. As you may have read, the clinical trials were conducted with 270 healthy adults in Austria and Singapore using four different antigen concentrations. These results indicate that our vaccine can induce antibodies that neutralize widely divergent strains of H5N1 suggesting that it may provide wider protection for a larger number of people before and during a pandemic.

Our Phase III clinical trials are expected to begin early next year with final results available before the end of 2007.

In addition to our clinical progress, we continue to be actively engaged in a number of discussions with governments around the world regarding our pandemic and seasonal influenza capabilities.

Our third quarter milestones also included the reimbursement approval and launch of ADVATE in Australia and regulatory approval in Canada. We would expect to launch ADVATE in Canada during the fourth quarter and we also remain optimistic regarding a late 2006, early 2007 launch in Japan.

In addition, we launched Baxject II in the United States. Baxject is a needleless transfer device used with ADVATE and designed to make the reconstitution and mixing of the therapy easier and faster. Safety is also improved by the inclusion of built-in filters to maintain product purity, as well as a reduced risk of injury because of the needless design.

Also, in August, we received FDA approval for ADEPT, an adhesion reduction solution and nubile surgery product that is used in laparoscopic gynecological procedures, which we will launch in the fourth quarter in the United States.

And finally we are pleased to announce the recent FDA regulatory approval of our new state-of-the-art plasma fractionation facility in Los Angeles for the production of albumin and lyophilized IVIG. We expect commercial production for the improved products to begin early next year. As you know, this new facility is expected to be more efficient and over time enhance the yields of our fractionation processes. We will transition production to the new facility throughout 2007 and currently expect approval for Liquid IVIG by the end of next year.

All in all, I think it has been a very productive quarter. Momentum continues to build internally with both [TR&D] programs and business development activities. While we are pleased with our progress financially and operationally, we are now increasingly spending our time and efforts on the goal of accelerating revenue growth and always with a continued focus on value creation. We look forward to discussing these efforts in more detail at the appropriate time.

So at this point, I'll turn the call over to Rob and then as I said, Rob, Mary Kay and I will be happy to take your questions. Rob?

Thanks, Bob. Good morning, everyone. I'm happy to be here today to discuss our financial results for the quarter and our outlook for the remainder of the year. Earnings per share for the third quarter were $0.57 and excluding special items recorded last year our adjusted EPS increased 21%. I am very pleased with the quality of our results as our earnings profile continues to reflect execution of the gross margin expansion opportunities we have identified, improved operating margins even after increasing investments in SG&A and R&D, as well as lower interest expense.

Our reported sales growth accelerated from 2% in the first half of the year to 7% in the third quarter. On an organic basis, sales growth accelerated two points from 4% to 6%. International sales continued to accelerate at a faster pace than in the U.S. with international now accounting for 57% of our total sales. International sales increased 9% on a reported basis and were up 7% organically driven by 6% to 8% growth across all three businesses.

U.S. sales increased 3% as very strong growth in Bioscience of 18% was partially offset by a decline in Medication Delivery sales.

Now, turning to the individual businesses. Let me first start with Medication Delivery. With sales of $950 million, sales declined 1% on a reported basis in the third quarter and were down 2% on an organic basis. While we anniversaried the impact of the COLLEAGUE pump and generic competition for Rocephin, this positive benefit was more than offset by a decline in our U.S. injectables, which is reported as part of our anesthesia and critical care business.

Overall, anesthesia and critical care sales declined 15% on a global basis. International sales increased 12% driven by the continued success of our inhaled anesthetics, Suprane and sevoflurane. This growth however was more than offset by a 27% decline in the U.S. as a result of intense competition for PROPOFOL and other multi-source generics.

PROPOFOL sales declined by approximately 40% sequentially and were down by approximately 60% year-over-year while other multi-source generics sales also declined in the quarter. Drug delivery sales increased 5% versus a decline of 3% in the first half of the year. Growth was driven by an acceleration in contract manufacturing revenues of more than 20% and solid growth of our premixed drug portfolio.

This growth was somewhat offset by a tough comparison on Ceftriaxone, the generic Rocephin, in the frozen premixed presentation. You may recall that approval for the generic frozen product occurred at the end of the third quarter last year driving continued volume of the branded drug during that time frame. Excluding this impact, drug delivery sales were up in the single digits.

IV therapy sales, which increased 4% on an organic basis, were driven by strong international growth of our nutritional products and low single-digit growth globally of IV solutions.

Finally, infusion system sales were up 7% with international sales of COLLEAGUE pump more than offsetting the loss to access set sales in the U.S.

Despite the challenges in the anesthesia business this quarter, the Medication Delivery business made good progress on several fronts. For example, sales increased within each of the businesses with the exception of anesthesia. In fact, sales growth accelerated infusion systems with the relaunch of COLLEAGUE internationally and in our drug delivery business as we continue to improve our operational execution with our new syringe filling capacity.

As a result, we continue to expect further sales growth acceleration in these two businesses in the fourth quarter. In addition, we have now launched sevoflurane in six countries around the world, including the launch in Mexico, which occurred at the beginning of October and we expect to launch in additional countries before the end of the year.

And, as Bob mentioned earlier, we continue to make good progress with our COLLEAGUE remediation efforts outside the U.S. We're working very closely with the FDA on our corrective action plan for U.S. our customers.

Renal sales of $519 million increased 6% driven by mid single digit growth in both our global PD and our hemodialysis businesses. On an organic basis, global PD sales have been growing 6% consistently throughout this year as we continue to focus on strengthening our global leadership position by partnering with governments around the world to establish PD as the first line of therapy.

International sales for the Renal business, which account for 82% of the total, increased 7% driven by strong PD patient gains in Latin America and Asia and growth in HD of 9%. With PD patient growth in the developing markets in the high single digits led by growth in China, more than 25%. We are also very encouraged that we continue to see patient gains in the U.S., Europe and Japan.

In Bioscience, momentum continued with a very -- with another strong quarter. Reported sales of $1.1 billion increased 15% with organic sales increasing 13%. This includes the sales of transfusion therapies, which declined 10% in the quarter. Sales in our core Bioscience business increased 19% with strong growth across our recombinant plasma therapeutic and biosurgery franchises.

Total recombinant sales increased 8% on an organic basis with record ADVATE sales of approximately $220 million. Strong factor VIII sales were somewhat offset by declining sales of BeneFIX, the recombinant factor IX product that we currently market for Wyeth outside of the United States.

As a side note, you may recall that BeneFIX's annual sales totaled approximately $170 million last year and we will be transferring these marketing rights back to Wyeth in mid-2007.

Global ADVATE conversion continues to go well with conversion of more than 60% globally. With the recent launch of ADVATE in Australia and Canada, we continue to expect full-year recombinant sales growth of more than 10% with ADVATE sales approaching $900 million.

Within the plasma business, organic sales increased 19% compared to last year as a result of volume gains, strong growth in FEIBA, our factor VIII inhibitor therapy, and a recovery in pricing for some proteins.

Antibody therapy sales increased 57% over the prior period due to increased volume, continued conversions to liquid Gammagard and a recovery in pricing. As a result, we continue to expect antibody therapy sales to exceed $750 million for the year.

Biosurgery sales increased 13% in line with our expectations and the other sales category declined as a result of lower third-party plasma sales. This decline was somewhat offset by growth in our vaccines business. Clearly, the BioScience business has had a very great -- a very strong year and as a result of increased ADVATE conversion and a recovery in the plasma business, we expect this to continue. The plasma market dynamics have been consistently improving and we remain encouraged that the balance between supply and demand is sustainable.

In addition, we continue to expect that over time we will continue to add increased value with our improved product mix, enhanced manufacturing yields and new product development initiatives.

Turning now to gross margin. Our gross margin in the quarter of 47.5% improved by 4.3 points compared to last year as a result of continued gross margin expansion in each of our businesses and lower costs associated with foreign currency hedges.

In addition, gross margin in the quarter benefited from improved business mix between BioScience and Medication Delivery and a series of favorable product mix dynamics within BioScience.

Within the businesses, the primary driver of expansion continued to be higher margins in BioScience, largely the result of improved mix driven by ADVATE conversion and conversion to Liquid IVIG. Increased volumes for higher margin, specialty plasma therapeutics, as well as a recovery in pricing for some plasma proteins also drove that improvement. In fact, for the total Company through the third quarter of the year, more than 80% of our margin improvement relates to mix upgrades and operational efficiencies with only 20% related to pricing primarily driven by the recovery in the plasma business.

The expansion we have seen this year is the continued result of specific actions that we are in the midst of executing, including upgrading our product mix towards higher margin products, realizing benefits from continued cost and yield improvements and more concentrated and redirected promotional focus on higher value products and selectively exiting lower margin, lower return businesses.

Overall, we are very pleased with our gross margin progression as we have continued the trend in achieving year-over-year margin improvements and it continues to reflect our confidence and commitment to improve margins over the longer term as we continue to make progress in executing on the margin expansion opportunities I referred to earlier.

SG&A of $562 million declined sequentially in line with historical trends but increased 15% over the prior year period. Three points of growth is related to the expensing of stock options and the remainder of the growth is primarily related to increased spending for marketing programs and new product launches, as well as foreign exchange and higher benefit costs.

As Bob mentioned, R&D spending of $149 million increased 12% reflecting our continued commitment to grow R&D investments.

Now, let me briefly discuss how operating margins shaped up for this quarter. As a result of gross margin expansion, our operating margin of 19.7% improved 2.4 percentage points compared to last year reflecting our continued focus on driving profitable and sustainable growth with operational discipline.

Importantly, as we have previously mentioned, our strong gross margin expansion affords us the opportunity to accelerate investments to grow the business for the longer term while at the same time allowing us to achieve our shorter-term EPS objectives.

Interest expense was $5 million this quarter, down significantly from last year as a result of lower net debt and a higher cash balance and other expense, which totaled $20 million, was higher primarily as a result of higher foreign exchange.

To summarize, net earnings increased 26% for the quarter with earnings per diluted share of $0.57. Excluding stock option expense, adjusted EPS increased 28% to $0.60 per diluted share compared to $0.47 per share in the third quarter last year.

Moving to cash flow, cash flow from operations for the nine months of 2006 totaled $1.4 billion or $100 million improvement compared to $1.3 billion last year. DSO of 55.9 days improved year-over-year and was primarily driven by continued improvement in our international receivable collections. Inventory turns of 2.4 are lower than in Q2 and prior year primarily due to lower turns in Medication Delivery as we continue to build COLLEAGUE pump inventory.

Net debt this year has been reduced by approximately $1.9 billion compared to last year and we ended the quarter with a reported net debt to capital ratio of 11%. In the third quarter, we also repurchased approximately 90 million shares of common stock or 2 million shares. Our repurchased levels for the quarter were lower than expected as we elected to cease all activity prior to the announcement of the Transfusion Therapy divestiture.

Year-to date, we have now repurchased more than $475 million of stock or 12 million shares. As we mentioned in the press release, we are well-positioned with respect to our cash flow objectives for the year as we continue to drive sustainable improvements in cash flow and return on invested capital. As we balance our investments and enhance our longer-term growth, we will remain committed to return value to our shareholders through a disciplined capital allocation framework.

Finally, let me conclude my comments this morning by providing our outlook for the full year 2006 and the fourth quarter. As you saw in our press release, we continue to expect organic sales growth for the full year of approximately 6%. This is before the impact of foreign exchange, which at current rates will be approximately neutral for the full year. Given our performance in the third quarter, we have raised our earnings guidance for the full year. We now expect earnings per diluted share of $2.17 to $2.19 before special items.

This assumes the following. Organic sales growth in BioScience for the full year of 12% to 14%, low single digit growth in Renal and flat to declining sales for Medication Delivery. For the full year, we expect our gross margin ratio to improve to approximately 46%. This assumes a fourth quarter gross margin that is consistent with our gross margin ratio through the first nine months of the year. Given our gross margin expansion, we have the flexibility to continue to make investments in R&D. Therefore we expect R&D growth for the full year to increase in the low teens.

Even after the impact of stock option expenses and investments in R&D and SG&A, we expect operating margin to improve by approximately 100 basis points from last year's full year operating margin of 17.3%.

With our low debt level, we continue to expect interest and other expense to be below prior year and expect a full year average share count of 655 to 660 million shares.

Lastly, we continue to expect cash flow from continuing operations to approach $2 billion with free cash flow in excess of $1.4 billion. Over the fourth quarter, we expect organic sales growth to grow 7% to 8% with earnings per diluted share in the $0.60 to $0.62 before special items.

Before opening the call up for Q&A, let me remind you that we will be providing our 2007 financial guidance during the fourth quarter earnings release scheduled for January 25, 2007. With that, let us open it up for questions. Thanks.

(OPERATOR INSTRUCTIONS). Ben Andrew, William Blair.

Just wanted to touch on a couple of things. Bob, I'm curious what you might have learned from the remediation efforts in Europe on the COLLEAGUE and how that may help you either move faster or more inefficiently in the U.S.?

Without getting too specific I guess at a high level, Ben, what I would say is we knew going in that, if anything, we had to overresource the remediation efforts. As I have commented very many times, I am not -- none of us feel too good about the position we put our customers in and I think how we execute our remediation efforts, both outside the U.S. and in the U. S., will go a long way toward determining whether or not we manage through this whole situation and come out stronger at the other end, which I believe we will.

So we basically resourced the remediation efforts significantly. We had people in accounts. We did everything to service our hospital customers in every possible way we could. Actually I could show you a pile of letters that have come in from countries around the world actually complimenting us and thanking us for the job we did with the remediation efforts. So I don't know if we learned anything from that, but I think those experiences reinforced how we need to proceed ahead in the U.S. and we're obviously committed to do that when, as I said, we get the green light.

Sure. And just in the BioScience division given the strength there, maybe talk a little bit more about the dynamics on both factor VIII recombinant in 2007, as well as what impact the Wyeth change midyear may have on the business because that is the first I've heard of that.

I will take the first part. Rob, you might want to comment on the Wyeth piece to get into the specifics. But obviously the whole recombinant franchise, as we said in our comments, we are protecting the growth for the year double digits. The conversions continue to go well. Obviously the slower rate in the U.S. than in Europe, but frankly there aren't any major deviations at least through the remainder of 2006 from what we have communicated to all of you previously.

Relative to 2007, frankly we will get into the specifics of that when we provide guidance for 2007 at our fourth-quarter earnings call. Rob, you want to comment on the Wyeth piece?

With Wyeth what we are looking at is -- as you know, BeneFIX is a product that we market for Wyeth outside the U.S. That contract ends midyear of 2007. So obviously as we go into 2007 given that the full year of sales is approximately $170 million, you are going to see an $85 million reduction if you will in sales in BioScience for the half-year effect. So we will see a half-year effect in 2007 and we will actually see a half-year effect in '08. Obviously how that impacts our overall guidance we will cover in our call on the fourth quarter in January.

Mike Weinstein, JPMorgan.

A couple different areas probably to focus on this morning. First, I will target the Medication Delivery. It looks like really BioSciences, Renal, most of Medication Delivery, everything was at or above our expectations. The one product line, which you identified, which came in below, was the anesthesia business, which it sounds like PROPOFOL, despite the fact that we are starting to anniversary some of the comparisons, took a pretty big sequential hit in the quarter. Can you tell us how anesthesia looks ex-PROPOFOL and how close we are to a bottom on an absolute sales basis? Thanks.

Let me comment on that. First of all, outside of anesthesia, we are actually pleased with the quarter-to-quarter, year-to-year growth in the other categories. IV therapies was up about 5%, drug delivery 7%, infusion systems 7%. You are right. The culprit was really anesthesia, but I think it is interesting to note that if you break out growth in anesthesia between U.S. and international, our international anesthesia growth was actually 15% versus prior year for the quarter.

As you know we don't really sell PROPOFOL outside the U.S. So I think that really reinforces the impact of this PROPOFOL erosion had in the quarter. Obviously, we want to preserve as much of the business as long as we can in PROPOFOL, but candidly if you are eroding at a rate very quickly, it is going to be not a material item in our base and frankly we were a bit surprised at how dramatic the falloff was in PROPOFOL.

There also was, and Rob didn't cover this in his formal comments, some stocking dynamics in Suprane for the quarter with the wholesalers and so on, which was a secondary contributing factor to the softness. So I think we will see the anesthesia business, which is really your question now. The anesthesia business very quickly get to a growth mode largely driven then by Suprane growth and obviously the sevo launches throughout the rest of the world.

And with Suprane, the inventory swing that you saw, how meaningful was that?

How low was that? I'm sorry.

How meaningful was the inventory swing that you saw?

It was a secondary factor to PROPOFOL. I don't that we have quantified it exactly. Rob, do you --?

I don't want to get into the specifics of what is going on in our channel. I think really the point is if you look in the anesthesia business, because we also carry our generic injectables in that number as well as PROPOFOL, it is masking it somewhat. If we had seen normal stocking for Suprane as we expected, frankly that would have covered some of what we are seeing in the multi-source business. So as Bob mentioned, it's a secondary effect. That's what he is really referring to.

But if you go back to where we were in the second quarter, obviously we had signaled at that time that we were anniversarying out COLLEAGUE, Rocephin and largely PROPOFOL coming into the third quarter. The event that has happened that we frankly didn't expect is that we have seen pricing pressures in PROPOFOL and even some volume pressure more than we expected and if you look sequentially, PROPOFOL is actually down $25 million from Q2 to Q3. So that is by far the largest driver of the drop you are seeing in anesthesia.

Also, and we don't usually talk a lot about it, but in our multi-source business, which had been showing growth through the first six months of the year, we did see in the third quarter that in our multi-source business, there was a decline. As we look to the fourth quarter, we expect it to come back to a growth position in part because we're going to be launching a couple of new products. We have Ondansetron. I think we have talked to you guys about it in the past, which is going to come out in the fourth quarter, as well as we have [Ceftazadine], which we also will be launching in the fourth quarter.

In addition to that, we are really moving for the first time into the flu season where with Azithromycin, we are going to get the first full benefit of having that product with us being the only authorized branded generic to go in the market. So that is going to be an uplift going into the fourth quarter in that space and then we had some supply issues on some of our smaller products that have also resolved themselves. So all in all, in addition to what Rob mentioned on anesthesia, you are going to see our multi-source business come back in the fourth quarter and obviously PROPOFOL -- we are just waiting for that to bottom out to get it out of our numbers. So that is really what is driving that line item.

Perfect. And then maybe just ask one (indiscernible) question for Bob. With the announcement on the Transfusion Therapy's transaction, obviously once that closes, you are going to be in a stronger position financially. You have a plan in place to buy back stock, but you have indicated all along that you are looking for areas to start to leverage the platforms and do some licensing and M&A. Any indications that activity is going to pick up anytime soon?

Yes, the activity will be -- it's already picking up within the Company from a planning point of view. Given the nature of what we are talking about obviously, these aren't things we can communicate until we've finalized arrangements. But it is why I said in my comments and I reiterated the same thing I said in my comments in the second quarter. The amount of time internally that we're spending business development activities today compared to a year ago has increased significantly. So we will let you know when something gets done.

Fair enough. Nice quarter. Thanks.

Glenn Reicin, Morgan Stanley.

Just to follow up to Mike. Is it possible you can just size the anesthesia business? It is my impression that last quarter PROPOFOL was around $50 million and Suprane was around $50 million and we were at the inflection point that the total business would grow again. Are you saying now that PROPOFOL business is a $25 million business per quarter?

That's correct, Glenn.

And Suprane is still in that $50 million range and it is still growing?

Yes, Suprane is nice. I would say mid single digit volume growth and we continue to have some pricing latitude on Suprane. So it is growing very nicely.

It is actually growing much faster outside the U.S. at more than 10%.

So with the remaining parts of the business -- so you've got $75 million from those two products, are we at the inflection point where you expect to grow in the fourth quarter?

Yes, we will expect to see Med Delivery grow in the fourth quarter. Again, if you look at the results, Glenn, looking through the third quarter, if I take out PROPOFOL, Med Delivery was up 1% and if I take out the multi-source issues we talked about, it was actually up 3%. And if you look at our line item results, we have seen good growth across all of the other segments within Med Delivery. So given the fact that the multi-source situation is going to turn in the fourth quarter, we expect to see Med Delivery grow in total in the fourth quarter.

I was just talking about anesthesia.

I'm sorry.

Glenn, anesthesia we expect to be up in the mid single digits in the fourth quarter.

And how big is sevo right now?

What's that?

How big is sevoflurane right now?

We haven't disclosed the sales of sevo obviously for competitive reasons.

You can if you want.

We know you have been pushing us to do that.

Okay. Let me just ask a couple of other follow-ups. Tax rate was particularly high this quarter. What is the story there?

Glenn, this is Rob. You know I think the guidance we have out there right now is that we are going to run a tax rate of 20% to 21% for the full year. What we are seeing now is the tax rate for the full year is going really probably approximate 21% and as we have looked at what is happening in the quarter, I think you are referring to the fact that I think it is 21.9%. Actually we had a deferred tax item that was booked in the quarter. So that is not a repeating event and we expect the tax rate in the fourth quarter to be down and the full year still to be and again approximate 21%. So that was really the driver of what you saw.

Okay. So lower than expected tax rate in Q4?

Yes.

The last question, which is a tough one, can you talk about what you're seeing in the plasma business with respect to effective pricing with and without the ARC element to it?

We continue to see anywhere between what I would characterize as price stability to pricing buoyancy. I mean we are getting pricing leverage now really across most of the plasma proteins. Going forward, that will not accelerate at the rate that we have experienced over the last say six to twelve months. I think you know that. But they will continue to be, I'll just call it pricing buoyancy across the plasma proteins going forward. We don't really see anything in the what I will call the supply demand equilibrium in the marketplace that has changed or in our view is likely to change going forward. As Rob said in his comments, the stability continues to be very good and so there will be some pricing latitude there going forward.

Can I just push here a little bit on something? On the ARC, if I understand correctly, this year, you will book sales of roughly $200 million and you are going to give up collection revenues year-over-year in the $40 million to $60 million range. Does that entire delta fall to the bottom line or are there additional costs associated with ARC?

I don't know what other costs you might be referring to. You know we basically are going to annualize the ARC incremental impact on the revenue line. We did that in the second quarter. We are converting all of our Polygam, which was the ARC branded product of IVIG over to Gammagard. We do have the contract manufacturing revenue that is annualized out as of Q2 that will no longer receive and haven't been receiving for the last year.

In terms of just -- we pay them now. We have a plasma procurement agreement so we acquire the plasma. That is in our costs. We had been contract manufacturing for them so from an operating perspective, there is no additional cost. Rob, I don't know if you have any other comments?

No, I think there is no -- obviously the cost we have is the cost of the raw material, the plasma. Other than that, it is running through our normal manufacturing and to Mary Kay's point, we have been manufacturing that for ARC historically. So there is no incremental cost in the manufacturing process from us continuing to do that activity.

It sounds like this was a large part of the year-over-year improvement in margins.

It wasn't a large part of margins. It was a large part of the total growth in volume of our sales because obviously by shifting it from being a contract manufacturer to now, we are putting the sales of the product into our sales line and we're recognizing the cost. It was a driver of revenue growth, but it wasn't a driver necessarily significantly of margin growth.

Okay. I need to connect with you then after the call and try to understand it a little bit better. Thank you very much.

Larry Keusch, Goldman Sachs.

Just staying on IVIG and plasma proteins. Bob, could you just walk through again sort of how you think about the growth drivers on a go-forward basis? I am trying to understand strategically how you think about collections and the need to expand that activity versus getting better efficiencies out of the LA frac capacity, etc.?

Our end objective is to ensure that our capacity, whether that be on the front end with plasma collections or on the back end of fractionation, including yield improvements that may emanate from conversion to new LA frac, are reasonably balanced with both current and anticipated market growth and market demand.

You know over the last 12 months, it is fair to say that across the spectrum of plasma proteins, the year-to-year volume growth, just the volume growth has been mid to high single digits. It varies somewhat from protein to protein. But generally speaking that has been the volume growth. We would anticipate that kind of volume growth going forward into 2007 if not beyond. So we really start with that and then we evaluate what yield improvements we are likely to get from LA frac, new LA frac.

Although I would emphasize that when you start up any new facility of this complexity and magnitude, it is not reasonable to conclude that you are going to get yield improvements immediately. In fact, some might argue that as you start up, it may not be as efficient as your old facility. So you've got the normal startup that you face through there. So that is really our objective. Our objective is to make sure that we have infractionation capacity that will support current demand and anticipated market growth along with volume growth along the range of what I described and obviously at the front end, we look at balancing our collection capacity accordingly. So that is really kind of the template or the paradigm in which we operate. Again, we don't see any significant either acceleration or deceleration in the kind of volume growth.

Now again I'm giving you high-level commentary IVIG versus albumin versus plasma derived factor VIII, U.S. versus global. You have got specific dynamics within that but a high level. I think that kind of characterizes how we look at this. Did that help? Does that answer your question?

Yes, it does. Just sort of a follow-up to that. Do you have any concrete plans right now to increase the collections or are you still in good shape there?

Well modestly, but only as it relates to meeting this demand requirement that I just described. There certainly aren't any major initiatives to dramatically expand plasma collection.

Okay. And then the last question is can you give us -- you have been kind enough to provide the BeneFIX sales and how to think about those comparisons, but can you help us just think about the profitability in that product just to again help us think about this?

We are not going to be specific in terms of the profitability, but directionally I would tell all of you that the level of profitability given the arrangement that we have with Wyeth is far less than what typically would be of one of our own specialty pharmaceutical products okay. So it is lower than you typically would expect. I guess that is as much as I will say this morning.

Okay. Super. Thanks very much.

Rick Wise, Bear Stearns.

Let me turn back to COLLEAGE briefly. Are you feeling less or more hopeful that you can get this resolved by the end of this year? Are you less or more hopeful getting back to the market in '07 and sort of concretely what is left to do now?

Well hopefully you detected from my comments I think a sense of optimism with the progress that we are making. The conundrum I suppose is we can't really get in the position to be specific or definitive until we actually get to that point and given the spirit of collaboration that now exists with the FDA on this, the last thing I want to do is get ahead of ourselves here and express some kind of a milestone that commits the FDA to one thing or another. I am just not going to do that and so I'm not trying to be evasive or cute in any way, but I hope you understand why I just can't today be in a position to give you a definitive date. All I can offer is really what I said in my prepared comments. But I have a reasonable sense of -- probably an increasing sense of optimism as to this program compared to where we were three months ago. That is maybe the best I can do for you.

I will take it though. If we could turn to the margin side. It is clear that gross margins continue to improve as you peel off lower margin businesses and makes some cost efficiencies. It seems clear that despite higher spending on R&D and SG&A, operating margins continue to improve. But as you called out, your operating margins are already approaching 20% plus/minus depending on options. Again, where should we think they can go from here? Where do you imagine they can go from here or are we done there and we really have to focus on the sales for leverage going forward?

Several things. First of all, I just want to be clear relative to those factors that have driven our gross margin improvement and while the portfolio pruning activities clearly have been a contributor and the whole turnaround of the plasma situation has been a major contributor as well, the one point that I don't want anyone to lose sight of -- I made the comment and Rob made the comment, in our prepared comments, perhaps a little bit obliquely so I will be more correct.

Every one of our businesses, every one of our businesses had higher gross margin percentages today than a year ago. And that is a byproduct in my view of more effective execution and everything that rolls up into gross margin percentage, which to me is the most important financial metric to really monitor the effectiveness of line management. So that is getting price where you can get price. That is obviously cost efficiencies. That is redirecting promotional efforts to higher margin products and everything in between.

And it is important given the significant run-up in gross margin percentages and people sometimes say well that is the plasma effect and so on. There is a lot more involved than that and it is important that everyone understand the improved margins in every one of our businesses and where that is coming from.

Now having said that, where can it go from here? We are obviously encouraged by the progress. Two years ago, I told all of you when asked the question, because you all asked the question, gee, what is the potential pretax operating profit as a percent of sales of the portfolio businesses that you are in and John and I at that time consistently said we believe we can get to 20% or beyond certainly and then when asked when, we answered that by saying in the intermediate term. Okay?

Candidly, I think we have gotten close to that point quicker than what we anticipated two years ago. That is very encouraging. That would suggest that certainly there is more potential long term for gross margins to improve and pretax operating profit to go beyond 20%. But how far beyond and when, again I will be no more committal on that than I was two years ago when I answered your questions.

But higher. Just last on the cash and interest front. You had $2 billion in cash. Where do you think cash balances will be at year end and when we are looking at interest expense, which was lower than we expected anyway on a net basis, it was 5 million. Is this the right level, Rob, to model for the next two, four, six, eight quarters or steadily falling down as cash balances build?

No. If you look at where we expect cash to be -- as you point out, we are at $2 billion through the nine months. That is up from $800 million, a little over $800 million a year ago. Cash will continue to grow. We will see cash grow in the fourth quarter. It will grow less than it grew in the third because obviously given the fact that we exited the market in share repurchase, given the imminent Transfusion Therapies divestiture, we still, as I think I indicated in Q2, we are still looking to replicate in the back half of the year what we did in the first half of the year for total share repurchases.

So you will see us continue to buy in the market in the fourth quarter. That will hold cash from growing. But so far what we have found through even when we were at our heaviest of repurchasing, we were repurchasing at a rate slower than our cash was growing. So you will see cash probably grow a little bit.

As you look at interest expense, you are not going to see interest expense going lower. I think we are probably close to where it is going to be. Obviously the cash build will drive a longer turndown if we continue to hold that much cash, but I don't think we are going to see it dramatically change over the next several quarters.

If I could stick in one other follow-up on that. You have talked about portfolio a little bit; you talked about share repurchase. It has been a long time since Baxter has increased the dividend I think. Might we see -- is this -- are we approaching a moment, Bob, where you would recommend to the Board hiking the dividend? Thanks.

As you know, we evaluate our position on dividend once a year. We typically do it at our November Board meeting. We will be revisiting that in our upcoming November Board meeting. Candidly, up until now, as you know, we have been more focused on some of the legacy issues on the balance sheet and so on and really didn't have the latitude to seriously reconsider our position on the dividend. I think it is fair to say that as we meet in November, we will be in a position to more seriously consider options on dividend than what we have been previously. Once we decide, we will communicate it.

Matthew Dodds, Citigroup.

A couple of questions. First, Bob, for IGIV, can you say what percent of the business is now converted to liquid, how it ended Q3 and how much that is up since Q2?

What is it, Mary Kay, in the U.S.? 40%?

It's globally 40%. It is higher here in the U.S. and it is about 25% in Europe.

And over what period do you expect that to move materially? Is there a trigger with American Red Cross or is that just a --?

It is just going to be fairly gradual based upon the ability to supply the liquid. So there is not going to be a -- don't expect a dramatic step function in that conversion, but obviously we know what the endpoint is and what our goal is.

Now the reality is today -- today is that given the pricing on the lyophilized, there is only a modest at best differential in the pricing. So the lyophilized pricing has come up and approached very closely the liquid pricing.

And then one separate question. I think you have another drug in Medication Delivery coming online in Q4. That is Ondansetron.

Ondansetron. Right. Rob commented on that.

When is that supposed to launch? When does the patent go?

It doesn't launch until December, mid-December, when the pediatric exclusivity ends on the branded product.

And today, are you still the only company with the pre-mix tentative approval on that product?

I don't know. I know there are a couple of other companies that have approval for the vial presentation. We may be the only company with the frozen.

Thanks, Mary Kay. Thanks, Bob.

Katherine Owen, Merrill Lynch.

Just one question and I apologize if you touched on this, but the sequential decline in domestic ADVATE sales, it was flat a year ago sequentially. Was there anything specific in that?

Last quarter, we talked about the fact that we had the stocking orders for the high potency ADVATE in Q2 that we didn't see in Q3.

Okay. So we should expect more normalized growth going forward?

Correct.

And then on the BeneFIX, I appreciate the numbers that you gave us. Should we assume this starts to trend downward in the first half of the year and then does it go away completely or is there any type of gradual reduction?

You will see somewhat of a gradual reduction, but it really will -- the contract ends mid year. So it is somewhat of a cliff effect. That being said, you will -- we frankly already are starting to see some declining sales of that product. So you will see it slow.

But a cliff as of mid year, there is no tail?

Yes.

And then just lastly, a question on the plasma and specifically as it relates to the pricing and the equilibrium we have seen or improvement in terms of supply. Bob, as you know, that business has been I guess cyclical for lack of a better word where we go in period where there is significant pricing pressure. Is there any reason to think or have there been any change in the dynamics of that business that it is going to be less volatile going forward or should we just assume that we will eventually go back to a period of excess supply for any reason?

I think there are a lot of dynamics that are different today than in the past that would give one cause for optimism that there will be much less volatility going forward. First and foremost, there are fewer participants in the marketplace. Secondarily, if you look at the excess fractionation capacity that exists worldwide today, the estimates would be somewhere in the range of 20% to 25%.

So back to my earlier comment about the annual volume growth across the spectrum of plasma proteins being mid to high single-digit, frankly the excess fractionation capacity that exists on a global basis today with the major players is going to be necessary to support normalized market growth over the next two to three years, okay?

Also there is significantly lead time in establishment of new fractionation capacity, anywhere from three to five years as evidenced in our own case by our new L.A. frac facility because that has a fairly long-term history to it from when we made the decision to the announcement that we made this morning about the regulatory approval. So collection capacity at the front end obviously can change and is more responsive, but at the end of the day, you have got to be able to fractionate the product.

So I think given the current fractionation excess capacity situation today, which is modest and necessary to support volume growth, given not only the number of fewer players but the kinds of players that are in the business now, okay?

The other thing I would point out is I think there is a misconception in this business that the volatility historically has been the result of one or more players dramatically expanding capacity and driving for share using price to drive share. If you go back over the history of this, more often than not any volatility has really emanated from a regulatory event. There has been a regulatory challenge that one or more of the competitors have addressed, at which time it tended then to distort the supply demand equilibrium as we call it in the market.

So we see a basis, I think, to be much more optimistic relative to -- I don't accept the fact that it's an eventuality that a new plasma cycle will come back. I really don't. And in our own case, of course, meanwhile we are moving to convert a lot of our products into specialty differentiated packaging that nobody else has. It is one of the reasons we are putting albumin in flex container. We're the only company that will do that. We're evaluating putting other plasma proteins in specialty packaging.

We are doing that one. It offers more functionality and utility for our customers. It gives us some more pricing latitude. But in the event there was a volatile situation longer term in the plasma protein business, the more of our products that we have in specially differentiating packaging, obviously, the better. So I mean, we spent a lot of time on this and thinking about this because of the leverage effect in our P&L, but I think there is every reason to have a reasonable degree of confidence that the stability is going to continue for the foreseeable future.

I just wanted to add one other thing. I think another differentiation from where we were in the past is obviously in addition to the packaging that Bob mentioned, seeing the growth in specialty fractions with Aralast, WinRho, FEIBA, that also allows us to diversify our total fractionation across a broader spectrum of fractions that brings more stability as well.

That's a great point.

And all of those are very high-margin products.

So it's a very different ballgame today, we think.

Thank you. That's very helpful.

Sean, we have time for one more question this morning.

Dhulsini De Zoysa, Cowen & Co.

Thanks. I'm happy to sneak in at the last minute. I was wondering, Bob, if you could talk some about the conversion and capacity utilization at LA frac throughout 2007. I am trying to get a handle on the potential margin contribution in '08 once you normalize. I would love to hear what it can do in terms of cost per liter of throughput or something less specific would be fine too.

I think unfortunately I will probably frustrate you a bit with the answer because I don't think we can be real specific at this stage. I mean we are confident that we are converting not only to a more efficient facility but one from a quality regulatory point of view is clearly state-of-the-art. I think sets the standard for the entire plasma fractionation industry.

Now having said that, I think it is far too early to be definitive as to what the normalized annualized margin contribution would be as a result of converting from old LA frac to new LA frac. We are still sorting through that and so it would be far premature I think to get into any specifics.

Could you then at least give us an idea of how you plan to phase in the facility?

Well, it is going to be a fairly long-term conversion. As I mentioned in my comments, the liquid IVIG, we don't expect to have regulatory approval out of new LA frac until probably late in 2007 and I don't -- again you don't know until you get it. But we have the whole spectrum of plasma proteins that we have to convert and not only in the U.S., but those products that are sourced internationally outside of LA frac. So it is a very complex regulatory matrix and it will be an ongoing conversion at least over the next couple of years. And that is another reason why I think it is real difficult to be more specific at this stage in terms of some of the cost margin implications until we get a little further down the road. We know there is an opportunity there; hopefully it will be significant. We believe it will be, but it is far too early to be too specific in that regard.

Then that might be the margin expansion in your back pocket for '08?

Could be.

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