Haemonetics Corp (HAE) 2004 Q3 法說會逐字稿

Good morning, ladies and gentlemen. Welcome to the Haemonetics conference call. At this time, all participants have been placed on a listen-only mode, and the floor will be open for your questions following the presentation.

Please note that during the course of this call, Haemonetics may make statements that could be characterized as forward-looking, and actual results may differ materially from those anticipated results. Additional information concerning factors that could cause actual results to differ materially is available in the company's press release and 10-K.

Mr. Brad Nutter, Haemonetics' President and CEO, will moderate this call. Here is Mr. Nutter.

Thank you, operator. Good morning. Today I am joined by Ron Ryan, our CFO, Lisa Lopez, General Counsel and VP of IR, and Julie Fallon, Director of IR.

Our comments today will cover three things. I will review market trends and developments across the business. Ron Ryan will provide Q3 and year-to-date operating results for the company and comment on division performance. Finally, I will update you on our core competency review process and have a few concluding remarks.

Let me begin by stating that we said this would be a year of transition as we reposition the business. We have made excellent progress. As you may recall, we began the year by setting realistic guidance, given current products and markets. Our guidance for the year was -- high single-digit revenue growth, gross profit margins in the mid- to high-40s, modestly improving operating margin, and EPS in the $1.13 range. I am pleased to report that we reaffirm this guidance.

As I stated on our last conference call, I will focus a bit more today on our patient division and its developing market trends. Although we may eventually add products that deliver value more broadly to the patients' hospital experience, the primary focus of our patient division today is surgical blood salvage -- and that's what I will focus on.

To review, Haemonetics invented blood salvage 30 years ago as a way to harvest blood. As a patient bleeds, the blood is suctioned into a sterile, single-use disposable blood processing chamber. That blood is washed to remove debris, and the red cells are then available for transfusion back to the patient. Without blood salvage technology, patients would have to be transfused with blood from a voluntary donor. So blood salvage became the standard of care in the 1980s as a way to avoid transfusions that could be contaminated with HIV or other diseases.

Today, the three factors driving blood salvage are -- one, reducing the risk of disease transmission, as well as bacterial infection, lung (ph) injury, and circulatory overload; two, eliminating the risk of being transfused with the wrong type of blood, the number one cause for a transfusion-related death in United States; and three, increasing cost and decreasing availability of donor blood.

Now there are two distinct markets for blood salvage, and they're basically surgeries with high blood loss and surgeries with low blood loss. The higher blood loss surgeries, where blood loss generally occurs while the patient is undergoing surgery, use the Haemonetics Cell Saver brand product. These procedures include cardiovascular surgeries, liver transplants, and trauma.

The number of high blood loss procedures that qualify for blood salvage globally is about 850,000 per year. Most of the market is penetrated, as blood salvage is considered, if you will, the gold standard of care for these patients. Forecasts indicate that usage in penetrated geographies will be level or decline. Now the factors impacting this trend are -- number one, improved surgical techniques and technology that minimize blood loss, both which obviate the need for blood salvage in some surgeries, and second, the use of stents, with -- reducing the number of cardiac surgeries, particularly in the U.S. Now research shows that from 2002 to 2003, the number of "cabbage" procedures in the U.S. has declined 8 percent. And this clearly affects our U.S. patient business.

Now given these dynamics, let me share with you how we are aggressively managing this business. First, on a year-to-date basis, we have gained approximately 1.5 percent market share through winning new accounts in United States. In this highly competitive market, we have closed 26 deals on competitive conversion accounts over the last three quarters. These include large hospitals, such as the University of Michigan and University of Nebraska. Second, we have increased pricing 3 to 10 percent for customers in the U.S. that are not under long-term contracts.

Third, we have targeted growth in some markets where we have lesser market share. For example, we have 40 percent share in Europe, where there are 270,000 cardiovascular procedures done annually that are qualified to use blood salvage technology. So this is a market worth focusing on.

Fourth and last, we strengthened our position in new markets. For example, you saw in a recent press release that we signed an exclusive distribution agreement for the Cell Saver brand product in Canada. In the short-term, folks, the additional revenue will be modest. However, the important point is not the added revenue, but the opportunity to penetrate and grow in a market where we have little presence. With a market potential of about 700 -- excuse me, 70,000 blood salvage procedures, Haemonetics is now positioned to grow in Canada.

So for our Cell Saver brand, mature markets are not growing. But we continue to gain share, and we have an excellent opportunity to leverage our market leadership and deliver sales growth in less mature markets.

Now I will discuss the OrthoPAT brand product, which is used in orthopedic procedures -- mostly hips and knees, as well as some spinal surgeries, where blood loss is lower, slower, and continues after surgery. This global market consists of about 1.5 million procedures, and is increasing more than 7 percent annually. Today, this market is less than 5 percent penetrated. With the only device specifically designed for low blood surgeries, Haemonetics is the leader in an underpenetrated, growing market. So you can understand why we're excited about this product.

Let me give you some more details on this technology and market. In orthopedic surgeries where blood salvage is not currently used, a patient sometimes donates his or her own blood prior to surgery. That blood can be transfused back to the patient, if necessary. If his own blood is not donated, and the patient requires transfusion during surgery, he must receive another donor's blood.

As I described earlier, some of the issues surrounding blood transfusion -- there are problems with donating your own blood in advance of surgery, also. A patient, often not feeling well, must go to a blood bank several times to donate blood before surgery. The patient's blood must be segregated, tracked, and available in the surgical suite. These logistical challenges are frustrating and expensive, costing between 600 to 800 per surgery, versus blood salvage, that costs less than $500 per surgery. As importantly, patients often enter the surgical suite anemic after having received donated blood, and surgical outcomes could be compromised, and hospital stays can be longer. The OrthoPAT system eliminates these challenges.

As a reminder, we acquired the OrthoPAT technology in December -- September 2000, and at that time we set out to create a new market, scale up manufacturing process, and improve quality. And we've completed all of those goals.

Internationally, the OrthoPAT markets are relatively small, but we are rapidly penetrating them. Over the quarter, revenue for this product grew 90 percent in Europe and more than 50 percent in Japan. So although European and Japanese markets are in their infancy, they represent exciting opportunities for us to create more new markets -- something that was done many times in the past.

In the U.S., the OrthoPAT system is distributed by Zimmer. As you saw this morning, we just signed a five-year extension of our contract. At our current sales growth rate, we estimate that this extension has the potential of 125 million in total revenues for Haemonetics over the next five years.

So two years ago, we had no OrthoPAT business. Then for the past two years, OrthoPAT usage grew in excess of 40 percent annually in markets around the world, demonstrating its growth acceptance by orthopedic surgeons. Currently, we expect worldwide OrthoPAT disposable sales to reach about (ph) $12 million for this fiscal year. We expect that global OrthoPAT revenues will continue to grow at meaningful rates. So this product line could represent a $70 million business in five years. Now to put that in perspective, that would be more than the total patient division's disposable revenues for all of FY '03.

Now let me switch gears and comment on our donor division. I'll start with some changes we've seen in the global plasma market and their effects on Haemonetics. Specifically, I will discuss Baxter's acquisition of Alpha Therapeutics and its impact on Haemonetics. Additionally, I'll talk about our markets today, and our expectations going forward, and Haemonetics' performance in these markets.

So first let's talk about Alpha Therapeutics. By way of review, when we signed supply agreements with Alpha in 2001, we negotiated protections in the event of change of ownership -- specifically, if Alpha were sold, the purchaser would assume our contracts. So with this purchase of Alpha late last year, Baxter assumed our supply contracts.

Now as you may recall, Baxter had previously closed 26 of its (ph) plasma collection centers, and then this was followed by the closure of 38 of the 41 plasma collection centers purchased from Alpha. Now there are several ways Baxter can honor its contractual obligations to Haemonetics -- first, purchasing our disposables to use at Baxter's plasma collection centers, or second, buying out the contracts.

At this point, Baxter is not purchasing Haemonetics' disposables. Settlement offers by Baxter were inconsistent with the terms of the contract. Haemonetics' Board and management team felt that we and our shareholders should realize greater value from these contracts, and therefore, we filed a claim for binding arbitration, which is the dispute resolution process required by the contracts.

Haemonetics is prepared to continue discussions with Baxter. However, at this time, we believe initiating the arbitration process is prudent. If during the next fiscal year, Baxter makes no purchases under these contracts, and the arbitration is not concluded, the sales loss to Haemonetics would be approximately $9 million. Should Baxter elect to honor these contracts with purchases, obviously, the sales loss would be less. Therefore, at this time, it's very difficult to predict the FY '05 impact.

As I stated a moment ago, these contracts were deliberately written with an eye to transition to new ownership after change of control. So we feel our position is quite strong.

Now let's look at the plasma market and see what trends we see going forward. As a reminder, over the last ten years, the worldwide market for plasma collection systems has nearly doubled from 125 million to 230 million, averaging 6 percent annual growth. During the same time, collections have increased from 10 million liters to 18 million liters annually. Demand for plasma has grown steadily, as demand for drugs like IVIG drive the need for plasma. We see that trend continuing (technical difficulty) firm.

However, the market still has excess supply. While many collection facilities have closed, we believe there is still in excess of 2 million liters of plasma in the United States. The market is working through this excess supply. Once the market stabilizes, though, we believe that the 6 to 8 percent annual growth in demand for IVIG will pull the plasma collection market to approximately 3 to 4 percent annual growth.

Currently, Haemonetics is outperforming the market by taking share, and Ron Ryan will give you specifics on this -- but let me recap that Haemonetics has a history of this. During the last five years, we grew our plasma disposable business from 85 million to 114 million, averaging 6 percent annual growth. So while our quarterly or yearly performance will fluctuate given market trends, our long-term performance has exceeded market growth rates, and we strive to continue that trend.

So the lessons learned about the global plasma market are -- first, industry consolidation has shown that collection capacity was out of balance with end-product demand, but U.S. capacity has now been reduced by more than 15 percent. Market intelligence indicates this change will stabilize the collection industry. Eventually, this will prompt another cycle of collection increases, and this is consistent with the fluctuations we have witnessed for more than a decade.

Second, for the last 15 years, we've had one competitor, and maintained a 50 percent global market share, despite losing business due to industry consolidation. Specifically, we lost $9 million in Serotec (ph) sales after our competitor bought it. But we made up that loss, and still grew global plasma sales. Folks, we can prosper in a declining market.

Third, we're confident that this market will continue to grow, notwithstanding periodic contractions in one part of the plasma supply chain, and in some way the plasma market will be volatile on an annual basis, but -- and this is the most important part -- over the long-term, it will flow at a steady rate.

Now, a few comments about the rest of our donor business. At the start of the fiscal year, we expected low growth in our blood bank product line. We continue to exceed our expectations, and I'm pleased with that. Let me describe two key dynamics driving the blood bank industry -- first, bacterial detection of platelets, and second, the need for U.S. blood reserves.

Bacterial detection is a test that confirms that bacteria are not present in platelets prior to transfusion. Bacteria can cause serious illness in patients receiving platelet transfusion. Systems for bacterial detection of platelets prior to transfusion are already in place in Scandinavia and the Netherlands. Effective March 1st, the American Association of Blood Banks is requiring bacterial detection of all platelets in the United States. On January 13th, Haemonetics was the first company in United States to receive FDA clearance for a platelet collection disposable with an integrated sampling pouch for bacterial detection tests. So our systems are ready for our customers.

In addition to having disposables that can accommodate bacterial detection, Haemonetics will serve our customers' needs regarding bacterial detection in a number of ways. For example, we've signed a distribution agreement with Hemosystem to distribute its bacterial detection tests in Europe, where the test has regulatory clearance. There are approximately 1.7 million platelet collections in Europe annually.

Haemonetics may also capitalize on this new trend through serving our customers' need to collect more automated platelets -- and let me explain. Because the bacterial detection test takes at least 24 hours to complete, the useful shelf life of a platelet is reduced from five days to about three days. Now industry experts anticipate that as a consequence, the number of platelets that outdate will increase significantly. In the USA, they estimate that platelet supplies will therefore decline 5 to 10 percent. Additionally, bacterial detection will make it impractical and very costly to use random donor pool platelets. We expect these factors to catapult the need to increase single-donor platelet collections, the market in which Haemonetics operates.

Haemonetics is particularly well-positioned to support this initiative, because we have the only system that can collect platelets on mobile blood drives. In United States, platelets have traditionally been collected by blood centers at fixed sites. But as blood collectors search for ways to increase their supplies, one solution being considered is reaching out to a new donor population by collecting platelets on mobile drives. This is an excellent opportunity, because 70 to 80 percent of U.S. donors donate at mobile drives. In fact, we recently signed a contract with Blood Centers of America, the nation's largest independent blood collector buying group, to try to capitalize on this opportunity.

Now the other blood bank industry driver I mentioned earlier was the need for blood reserves. In August, the U.S. Health and Human Services Committee for Blood Safety and Availability dedicated a day of hearings to this topic. A highlight of the expert testimony was the need to maintain frozen blood reserves. Frozen blood can be stored for ten years, and Haemonetics has the only system that thaws blood in a way that it's allowed to be stored, once liquid, for up to 14 days. Other technology only allows 24-hour storage.

We recently announced a new regulatory clearance for this system that makes it easier for civilian blood collectors to maintain frozen blood reserves critical for times of emergencies, or for patients with rare blood types. This is a niche market of about $10 million, but truly an innovative product addition for us.

Now let me shift my focus to the final part of the donor business, and that's the emerging red cell marketplace. In the United States, only about 2 percent of red cells are collected on automated technology. Frankly, our primary competition here is whole blood. Blood shortages, the economies of blood collection, and a focus on good manufacturing practice drive demand for this product. As some of you may have read, blood shortages are delaying elective surgeries in the southern United States.

In a national appeal for blood donors issued January 12th by the American Association of Blood Banks, American Blood Centers, and the American Red Cross, Secretary of Health and Human Services Tommy Thompson said, and I quote -- "The nation is facing a critical shortage in communities across the country. If blood supplies do not immediately increase, patients, accident victims, and those whose lives depend on regular transfusions are at risk for not getting the blood they need."

Folks, this is a national call to arms, asking people to donate blood. Unfortunately, efforts at recruiting new donors are being offset by ongoing increased restrictions on who can donate blood. The flu, mad cow disease, SARS, West Nile virus, are currently impacting donor eligibility. As science improves blood safety through more sophisticated disease detection, more potential donors will be eliminated.

The good news is that we have technology that can solve this problem. In fact, the only way for blood collectors to significantly increase their blood supply is through automated red cell collections. Dr. Ron Gilcher, President of the Oklahoma Blood Institute, posted an editorial in the December issue of Transfusion that states, and I quote -- "Donor acceptance of automated red cell technology is very high. Its time has come, and it's time to end red cell shortages in the United States." Folks, Haemonetics has an advantage over the competition, with years of experience in programs and services. We are the clear market leader in this market segment.

With that overview, let me turn to Ron for more comments on our business accomplishments this quarter. Ron?

Thanks, Brad. Good morning, everyone. I'm pleased to report on another quarter of solid performance against our goals. Our performance supports the annual guidance that we set early in the fiscal year, and we reaffirmed that guidance. To remind you, Q4 will have an extra week as we adjust our fiscal calendar year. Today, I'm going to share our third-quarter financial results and give an operational update.

Revenue was $91 million for the quarter, 4 percent over Q3 '03, and $267 million year to date, 4 percent over last year's first three quarters. Revenue comparisons include $6 million of equipment sales in FY '03 that were not totally duplicated in FY '04.

Disposable sales, representing 90 percent of our revenues, are the best indicator of how our business is doing. So let me share these results with you. Disposable revenues were $82 million for the quarter, up 6 percent over Q3 '03, and $240 million year to date, also up 6 percent over last year. Breaking this down into product lines, I will first address our results in the donor division, which is made up of the blood bank, plasma, and red cell product lines, as well as services, since much of the services revenue comes from the donor product lines. These product lines combined represents 75 percent of our business.

In plasma, disposable revenue was $27 million for the quarter, down 9 percent from Q3 '03. Year-to-date disposable revenue was $87 million, 1 percent below FY '03. Three factors affected our plasma business in the quarter. First, the downside -- the loss of plasma sales resulting from Baxter's acquisition, then closure, of Alpha's collection centers reduced quarterly sales by $3 million. Second, the upside -- if you look at our current U.S. plasma customers, they grew 6 percent in the quarter. Simply, put our customer base is growing collections faster than our competitor. Finally, another upside -- we signed three significant agreements. One customer committed to disposable usage for another two years. Another customer signed an exclusive agreement for 2.5 years, which includes conversion of four centers from our competitor's technology. And the third customer signed an agreement, making us their exclusive provider of their plasmapheresis technology, disposables, and solutions for five years.

The loss of the Alpha business and Baxter's failure to purchase disposables under our contracts will have a short-term impact on our P&L. But the market trends Brad spoke about earlier suggested that we will have a return to previous growth levels.

Now turning to the blood bank business, which consists of platelets and cell processing, disposable revenues were $30 million, up 12 percent over Q3 '03. Year-to-date disposable revenues are $82 million, up 9 percent over FY '03.

As you know, the platelet collection segment of the blood bank market is a mature market. There has been no growth in platelet collection over the last few years, as increased collection efficiencies offset increased demand for platelets. Yet even in this market, we have shown growth. We look to continue this trend, particularly in the U.S. market, where our share is currently less than 10 percent. As the availability of platelets comes under pressure with the onset of mandatory bacterial detection, we expect customers to continue mobile platelets collections as one strategy to increase supplies. The new agreement with Blood Centers of America is a first, yet important, step towards this.

Red cell disposables were $5.5 million, up 41 percent over Q3 '03. Year-to-date disposable revenues are 15 million, up 39 percent from FY '03. In Q3 in the U.S., we grew red cell revenues 45 percent from the same period last year.

The quarter has some exciting red cell highlights. We gained 6 new customers, including a company record of four regions of the American Red Cross. Haemonetics' technology is now installed in 15 of the 35 Red Cross regions. These regions combined collect about 3.3 million units of red cells annually. In addition to gaining new customers, we converted three customer sites to our white blood cell filter technology. Filtration with our disposables supports customers' good manufacturing practices, reduces manual processing steps, and increases profitability for them and for us. In general, we made solid improvements in growth in the quarter, and are well-positioned to meet red cell guidance of better than 40 percent year over year.

Service revenue for the quarter was $5 million, down 7 percent from Q2 '03. Year-to-date service revenues are 15 million, up 10 percent over FY '03.

Now let me turn to our patient division. Disposables revenue were $20 million, up 16 percent over Q3 '03. Year-to-date disposable revenues are $55 million, 8 percent over FY '03. Q3 growth improved from Q2, when sales grew 2 percent.

Brad spoke about the patient division and its markets earlier, so I will summarize that our sales success in this quarter is due to increasing OrthoPAT sales, gaining new Cell Saver customers despite declines in open-heart surgeries, pricing increases, and penetrating the market in undeveloped or lower share regions.

Now I will discuss our P&L and balance sheet. Please note that we have again posted a detailed breakout of our P&L and operating cash flow metric in our web site.

Now four factors affected the P&L for the quarter and year-to-date. First, we grew sales and established businesses faster than market growth, while sustaining high growth in red cells and OrthoPAT. Second, we saw positive dropthrough in the quarter. When I say dropthrough, what I mean is that we leveraged 4 percent sales growth into 5 percent gross profit growth and a 19 percent increase in operating income. This is the result of a combination of structural manufacturing cost reduction and operating expense restraint. You can see this in our gross margin increase of 50 basis points, and operating margin increase of 190 basis points.

Third, the income tax rate increased to 36 percent this quarter, while last year's tax rate of 13 percent included $4 million from an anticipated tax refund. Fourth, the company realized a second quarter reorganization charge of $2.6 million which affects our year-to-date comparisons.

Going through the specifics of the P&L, earnings per share were 38 cents in Q3 '04, compared to 42 cents in Q3 '03. EPS is 81 cents year to date, compared to 94 cents in FY '03. Year-to-date EPS for '04 were reduced by a negative 7 cents per share related to the second quarter reorganization charge and the change in the tax rate.

Gross profit dollars were 43 million, and gross margin percentage was 47.5 percent in Q3 '04, up 5 percent in dollars and up 50 basis points, respectively, over Q3 '03. Gross profit dollars were 124 million, and gross margin percentage was 47 percent year to date, up 5 percent in dollars and up 30 percent -- 30 basis points, respectively, over FY '03.

Operating expenses were $29 million in Q3 '04, held to Q3 '03 levels, and 93 million year to date, up 7 percent over FY '03. If you exclude the $2.6 million reorganization reserve that we took in Q2, year-to-date expenses are nearly $2 million below last year in local currency.

Operating income was $14 million in Q3 '04, up 2.3 million from Q3 '03 and $31 million year-to-date -- even with FY '03, mainly due to the $2.6 million reorganization reserve that I just mentioned. Operating margin was 15.5 percent in Q3 '04, up 190 basis points from Q3 '03, and 12 percent year to date, down 50 basis points from FY '03. The lower year-to-date operating margin is due entirely to foreign exchange.

During the quarter, our Customer-Oriented Redesign for Excellence, or CORE program, generated $1.9 million of operational cost reduction, bringing year-to-date savings of $4.3 million.

Our balance sheet strengthened again this quarter. We produced $25 million of cash flow from operations and 34 million of total cash flow. Examples of achievements this quarter include --first of all, we held disposables' finished goods inventory at 5.7 turns and reduced inventory by $3 million. Accounts receivable declined by $3 million as days sales outstanding were reduced to 77 days from 82 days last quarter. This is our best DSO performance in the last six quarters. Again, we managed capital expenditures below depreciation expense. And finally, we received the $4 million income tax refund, collecting on the P&L gain we approved in Q3 of the last year.

In addition to cash from operations, we generated $11 million from stock option exercises. We now have $97 million of invested cash, and $67 million of short- and long-term debt. We've worked hard over the past three quarters to improve our cash position.

A few final thoughts in the quarter. I'm pleased with the positive dropthrough we've accomplished through this year, and more specifically, in Q3. We're leveraging our P&L and our core business. This is important for the future growth of our core business, and a discipline that we will always apply in all parts of our business.

Now I'll turn the discussion back to Brad.

Thanks, Ron. On our last call, I promised to give you an update on a strategic planning initiative which is anchored by our core competency review. Today, we've surveyed all 1,500 employees regarding our core competencies. We are now analyzing that data to identify the ones that may be leveragable. As we finalize that step of the process, we will report our findings.

We know that our base business is solid and generates a significant amount of cash, in that our balance sheet is strong. But core competency review will hopefully allow us to identify opportunities to take us in new and different directions to grow the top line. So we'll take the time necessary to methodically read this review. We've made good progress on this important initiative.

So let me sum up with a brief recap of our accomplishments. Our marketplaces are challenging; however, we continue to outpace market growth in key areas, and have delivered overall disposable sales growth exceeding the plasma and blood bank markets. As emerging markets, the red cells and OrthoPAT product continue to meet our growth expectations of 40 to 50 percent. Our new agreement with Zimmer, which is a five-year agreement worth potentially more than 125 million, will greatly expand our product division revenues.

This organization understands the need to change, has been willing to change, and continues to focus on delivering results. Tough actions taken earlier in the year have proven a basis upon which we've seen positive dropthrough in our P&L. There will continue to be short-term challenges in the plasma market. However, blood bank growth, our new OrthoPAT agreement, the growth of red cell markets are all clear indications of opportunities going forward. I'm confident in our future. And I thank the Haemonetics team for their energy and commitment to delivering shareholder value. We are gaining momentum in our efforts.

Now at this time, operator, I'll turn the call over for questions.

(OPERATOR INSTRUCTIONS) Steve Hamill, U.S. Bancorp Piper Jaffray.

Good morning, my first question has to do with the reduction in operating expenses. It was quite a remarkable decline, especially on a sequential basis, from September, given the fact that you already had some of your restructuring benefits in the September quarter. So I was just wondering if you could talk a little bit about the discipline there that was able to drive such a dramatic reduction?

Sure. Ron, you want to give some additional color here?

Yes, thanks, Steve. Just as we indicated, compared to last year, local currency expenses were reduced by about $1.9 million. And this has really represented that we're working very hard to reduce our rate of spending to gain more leverage in the future. Part of this lower expense rate now reflects the benefit of the organizational change that we made in the previous quarter. We also have moderated our unnecessary spending while we continue to report the very important programs of the company proposed (ph) for future growth.

And if I could follow up on that, then, Brad, in terms of R&D spending -- you know, R&D spending was down about 12 percent year over year. And I just was wondering if you felt like this level of R&D spending is sustainable, if you really want to try to drive faster top-line growth in the future?

Yes, Steve, let me take a couple of cuts at that. Number one, you're dead on the money with that 12 percent reduction. And basically what we're doing is we're refocusing our efforts in R&D on a couple of products. In the donor division, for example, Pete Allen and his team were looking at a number of different projects. They're now focusing on a couple of projects. And therefore, we saw some opportunity to refocus after the reorganization. Additionally, another way for us to grow -- and as you have seen with our Canadian distribution agreement, for example, Hemosystems agreement -- these are examples of growing through partnership with others.

So when you look at our total R&D expenditures, I am comfortable with where they are today. I don't believe at all that we're sacrificing future product development. But we're also strengthening our position by looking at partnership opportunities with others throughout the globe to continue to find ways to move our top line.

James Sidoti, Sidoti & Company.

Good morning, Brad. Can you just -- you talked a little bit about bacterial detection in your agreement with Hemosystems. Is there potential there for you to extend that to the U.S.?

You know, I think so. Our -- bacterial detection is going to get confusing from a global perspective. I think we -- what we have to do is we have to either position ourselves with the right partners, as we have in Europe, to address local market conditions, position ourselves in terms of what we have done with our bag (ph) to get ready to go with that, as I mentioned in our conference call. And I think we're making real good progress there.

You know, this hasn't snuck up on the industry. I think people have talked about bacterial detection for some time. And I think we've been well-prepared for it. I feel that we're positioned perfectly. And I see opportunities to look at how we might continue to work, not only on bacterial detection, but I think pathogen inactivation (ph) will continue to be another source of challenge for our industry. And I think we have a couple of options there that we are well-positioned with as well. Lisa?

Jim, let me just add that that technology is not yet approved for marketing in United States. But Hemosystems does have plans to file for marketing clearance.

Now on the same topic, have you -- do you have any sense on how many of your customers are already doing the test? And how many are waiting for the March 1st date?

At this point, Jim, across the board, I don't. I could dig in and give you some more detail on that market by market, going throughout Europe and the United States. So I'd be happy to follow-up with you on that kind of information, if it would be helpful.

Greg Mokosko (ph), Lord Abbott.

Yes, thank you. Perhaps we could just look at the -- on an overall basis, the operating margin, which went from 14 percent to 16 percent of sales on a year-over-year basis, which is a very nice improvement. Could you give us a sense of what pieces of that improvement might not be as maintainable -- if, in fact, that's true? I heard that the R&D piece, but is there is foreign exchange issues, perhaps, that came in there? Just to summarize that so we understand that?

Sure -- Greg, this is Brad. Let me take a quick crack at it, and then I'll give Ron a chance to provide some additional color.

You know, since coming to the company, I've talked a lot about the fact that I believe a good operating discipline is to try to make sure that we have positive dropthrough from sales to gross profit to operating income. I'm pleased with the kind of dropthrough that I've seen, and Ron's talked about it. For two quarters in a row, we've seen that same kind of positive dropthrough. So it's a discipline as we try to operate our business that we'll continue to focus on going forward. And Ron, you can give Greg some specifics of where you see us going here.

Well, Greg, just as a follow-on to your question about foreign exchange -- as you will see in the Appendix that we put on our web site, our margins actually improved -- both gross margin and operating margin in the quarter and year to date in local currency. The primary -- we have several drivers of the improvement in our operating margin. Number one is the continuation of structural cost reduction, which I just alluded to from our CORE program, and secondly, our ability to maintain expenses at a level -- or in the third quarter reduction from last year. As our revenue begins to respond to programs that we have in place to continue to grow beyond the growth of markets in our core businesses, operating leverage will continue to help our margins.

And I'd just add Ron, that in our operating (ph) margin of 15.5 percent is up 1.9 percent from 13.6 percent of last year. So I like those kind of numbers, guys, and we hope that we're starting to get the discipline in place to continue that trend, Greg.

Okay, good. And then just, again, to help us overall understand the earnings growth relative -- at the bottom-line, relative to the tax rate, and the other issues, just on the quarter was the -- you know, if I look at income before taxes, as you showed, grew 22-plus percent in the quarter. Give us a sense of what -- maybe at the net income line, what that number would have been if we take out those one-times again, and so I understand that?

The tax rate comparison to last year is about 12 cents a share. So a good way to look at the underlying growth of the business is to look at the positive dropthrough, both in our margins and also the percentage of growth. Those are probably the primary things I would say, Greg.

(OPERATOR INSTRUCTIONS) Keith Markey, Value Line.

Hi, thank you. I have two questions. One is regarding your capital expenditures for this year. Could you give us your budget, and if there are any major projects, could you mention what they are? And then secondly, I was wondering about the status of your R&D pipeline. We haven't heard anything recently -- or at least, I can't recall -- about the mobile apheresis system, or what had been called Chairside Separator for automated whole blood donation?

Yes, I'll kick off with the question on capital expenditures, and then turn the R&D question over to Brad.

Actually, our capital expenditures are broken down into two significant categories -- number one, the normal PP&E at our manufacturing operations, and secondly, the value of the equipment that we place with our customers, and then we own and depreciate. Our capital expenditures have been running somewhat lower than depreciation and somewhat lower than past trends. And it's primarily a combination of lower PP&E, as there are timing factors, ups and downs, and the normal expenditures for manufacturing operation -- and secondly, lower placements of customer equipment. Our equipment is placed on the basis of demand from our customers. And we measure the utilization of our equipment to ensure that we're not overplacing equipment as a way of managing our balance sheet and cash flow. Now, I'll just ask Brad to address the R&D question

Yes, thanks Ron. In the donor division, specifically, we've had three patent (ph) forms that we've done a lot of work on -- our MCS Pro, our red cell collector, and our Chairside Separator. Joining the company, Pete Allen and his team have taken a look at the amount of activity we have in those three new platforms, and have tried to prioritize -- not stopping work on one, but trying to focus their work on the ones that give us the biggest bang for the buck. And at this point, as they go forward with R&D, they're focusing their energies on the MCS Pro and the red cell collector. That's not to say that we're not going to do work on the Chairside Separator in the future. But we're putting our resource dollars so we can try to get those product lines through the pipeline as quickly as possible. And that's kind of an overall tenet in terms of how we're trying to focus R&D activities.

You asked specifically about the red cell collector, which is our next-generation red cell project. And our current plans are for Phase I clinical trials to begin this quarter, the quarter that we're in, both in the United States and in Europe, followed by the required Phase II clinical trials, filed by a 510k application in FY '05 in the United States.

Todd Devoit (ph), Magstar (ph).

(multiple speakers)

Stan Mann (ph), Haemonetics Chicago.

Brad, two questions, one -- can you hear me?

Yes.

The SG&A progress as a percentage of sales -- the overall efficiency looks like it's moving in the right direction. Can we expect continued progress in the next several years on holding that SG&A and leveraging it against sales growth?

Yes, it's a good question, Stan. You can absolutely expect that. You know, as a percent to net sales, if you were to back out on a year-to-date basis our one-time reorganization charge, we were running at 34 percent last year. And now, we're down to 32.4 percent this year. So we're making progress. I believe that that continued discipline is the right thing to do. Clearly, we took a real look at just operating expenses. But the reorganization to try to position ourselves to better serve our customer with two divisions, I think, will continue to pay off over the long term, Stan.

Okay, second question is the Baxter double red cell separation -- I think it's Axis (ph)?

ALYX, yes.

Where is that -- what kind of progress has been made in penetrating against the Haemonetics unit?

Yes, we have seen a little penetration of that. I think they're finding as -- because they're a very good company, the same challenges we have found when we introduced the technology in the marketplace. Getting customers up to speed on this technology, changing standard operating procedures and so forth, getting things moving through the system takes quite some time. So we're not at all surprised with the fact that there's a long process to get new technology and changing customers' perceptions of how to use this technology. So the fact that we haven't seen a lot of units placed does not surprise me. It's a tough task. And as you know, we have struggled with that, and we would like to have been further ahead of where we are today. But it's a daunting sales challenge.

Terry Larry (ph), Kramer Rose (ph).

Hi, Brad and Ron. Great quarter, and really like to see a lot of the things that are working in our direction. I wanted to focus on two areas -- first, in the revenue growth -- your guidance, you're still expecting high single-digit revenue growth. And so far, it's been 4 percent year-to-date. And we've had some of the issues, like the loss with (ph) Baxter and from the plasma issues. So maybe you can talk about the key drivers and where the acceleration is going to come from to get to the upper single-digits growth?

Sure. Ron, want to take the cut at that? And I'll do the same.

Yes, let me just talk -- in that we have confirmed our guidance for the year. We've posted our year-to-date results. Just to help with the bridge -- first of all, we see revenue in the fourth quarter growing more than the first three quarters for really two reasons. First, please be reminded that there's an extra fiscal week in the quarter to catch up our fiscal calendar. And secondly, the exchange rates that we locked into last year were significantly stronger.

And that really leads me to my second comment, which would be the bridge from the year-to-date earnings per share result to our expectation for Q4. So in Q4, we would say earnings benefiting again from that 53rd week; second, continued favorable dropthrough from our operations, operating leverage and expense restraint, as we manage -- as we mentioned. And then, finally, for the year -- and therefore for the quarter -- we're looking at 5 to 10 cents of favorable foreign exchange. And that would -- that's what factors into the revenue growth as well.

I'd just take another cut at it here, Ron. If we look at our plan and how it was spread when I joined the company, we spread a lot of the plan in the fourth quarter. I'd like to see us get a discipline of looking (ph) from a billing dating (ph) standpoint as to where we are here.

So, we have a relatively steep plan in Q4. But, I am confident that, as Ron indicated, for those factors -- but other factors, such as our new Zimmer agreement, perhaps we can get a little traction on that. The things that we're trying to do in terms of Hemosystems in Europe -- that's a new opportunity for us. Dr. Sakurada and his team in Japan have had a new agreement with a product line called the Bair Hugger in Japan, where we've seen some pretty good traction. So you couple these things with OrthoPAT growth and red cell growth continuing, and we think that, in combination, we have opportunities to get there by year end.

It would be great to see the revenue growth acceleration and the impact of the new products. I know the discussion -- a clear (ph) discussion is never over until we get into the FX issue. I am just wondering if maybe on a more big picture way, you can kind of walk us through the FX, how it should be impacting the financials -- and particularly, as we go forward, as the dollar continues to weaken, how it should that benefit Haemonetics, given your exposure and your FX policies?

Sure. Ron?

Yes. First, let me remind you that we've posted a full analysis of foreign exchange impact on our revenue and P&L for the quarter and the year to date that's on our web site.

Generally as an overarching comment, we lock in on foreign exchange rates in the current quarter for the period four quarters out. And so we have locked in through this period for the comparable period next year. As you point out, the dollar has weakened -- had weakened in the first and second quarter, and particularly it's weakened since the beginning of this third fiscal quarter. And so we certainly see foreign exchange benefits in the horizon in FY '05, the year that's upcoming.

I'd take one just additional comment -- as you may remember in Q2, Ron reported that we had done some work looking at how others -- companies similar to us treat FX. And we feel that from a best demonstrative ph practice standpoint, we're comfortable with how we've treated FX in the past and going forward.

Robert Dunn (ph), Biscock Lucie Brothers (ph).

I'm wondering -- as a worst case, the $9 million in plasma sales from Alpha goes away totally next year. What would be the impact of that on net income? Can we assume a 10 percent after-tax margin on that kind of business? Or is it actually less?

Hi, Bob; this is Ron. I guess the best way to look at any revenue change is to take our gross profit margin, which is -- our guidance for this year is mid- to high-40s. Also, factor in that we have a certain amount of fixed cost in our manufacturing cost. And so there's, if you will, reverse operating leverage. And that's the kind of thing that would flow down to the bottom-line.

My impression, though, is that the plasma business does not have a 45-percent gross margin. So mightn't it be less than that?

It can be. We don't, as you know, Bob, break down our gross margins by individual product. But as a ballpark, what I indicated is probably a reasonable assumption.

And Bob -- this is Brad -- that margin is less in the plasma product group than it is in other parts of our bank (ph).

Steve Hamill, U.S. Bancorp Piper Jaffray.

Yes, Brad, I just wanted to talk a little bit about the situation in Japan with your blood banking business. You now have some new competition there from Gambro, who's got approval of the Trima. And, you know, that's obviously been a very strong product for them elsewhere in the world. What you doing to prepare for that competitive launch?

That product line is a very good product line. I'm thankful that we have tremendous relations and more than 70 percent market share with the primary customer, the Japanese Red Cross over there. So we have ongoing discussions with the Japanese Red Cross as to the value of our -- value proposition in platelets, how we continue to do a great job of servicing them. We've done an extraordinary job -- not only protecting that market share, but over the year, growing that market share, Steve.

So we all recognize that new products come into new marketplaces, and all product should be evaluated. But the strength of many years of high, high market share, I think, position us very well -- because our technology is well-accepted, well-understood.

And the final part that I think is most important -- and it goes back to some strategic decisions we've made over the years -- is we have done a great job of making sure that our quality meets the exact specifications of the JRC. And our quality standards are sufficiently rigorous. And we have great manufacturing partners in that part of the world. And that was a great strategy decision made by Haemonetics in the past.

So when you compete from a Japanese perspective, quality is issue one, two and three. And we've done a great job with our quality in that part of the world. And I think it's -- if you will, perhaps a barrier of entry to some standards for others to compete against us on.

And then one follow-up, if I could, in terms of the new OrthoPAT agreement with Zimmer -- in addition to extending the term of the relationship, are there other changes in terms of the transfer price, whatnot -- in essence, you know, could there be an improvement in your profitability from that relationship?

It's a great question, Steve. You know, that agreement is -- that we've extended with Zimmer -- and they're great partner. I'm so pleased with this agreement over the next five years. It's confidential, and we're not discussing the specific terms other than the information that I shared with you today. So we're real comfortable sharing that this is a great growth vehicle, a great opportunity for us. But the details of that specific agreement -- we have agreed between Zimmer and Haemonetics to keep those confidential.

Greg Mokosko, Lord Abbott.

Yes, thank you. Just with regard to the plasma business -- you said 50 percent market share, and yet you talked about a closing of Baxter centers and an increase in centers, with three customers converting some centers. And you've been saying 50 percent share for some time. Is that realistic? Isn't shared share growing?

It depends on how you look at it, Greg. If you look at the number of centers, the number of centers -- we have 50 percent of the market in the U.S., for example, and Baxter has 50 percent. If you look at the number of collections and procedures on a global perspective, we have our 50 percent and they have 50 percent.

Now the interesting part of the dynamic here is our customers are growing. Our customers are collecting more plasma. Therefore, that's why when the market is growing -- declining at a rapid rate, we are in the fortunate position because of our customer base to see our customers not decline at the rate of the market in terms of collections. So that has positioned us very, very well.

You're gaining share. Would you talk about the --

Thank you, Greg.

Would you talk about the cost of the -- was there any cost for the negotiations with Baxter? And should we -- just looking at it realistically, next year, if there is -- you know, with continued arbitration, etc., etc., shouldn't we expect some kind of legal cost from this situation?

I'll ask Lisa, who has done a good job of negotiating and discussing things with Baxter, to comment on that, Greg.

Well, certainly, litigation has its cost. But the arbitration provision, frankly, is the most cost-efficient way to resolve any dispute. We would expect on a very conservative basis it could take somewhere between 18 and 24 months if the process goes all the way to conclusion. And the costs of the proceeding, frankly, are recoverable by the prevailing party.

But at this point, the expectation is that there's not going to be -- I mean, just inviting arbitration, there wouldn't be ongoing costs for that. Is that correct?

That's correct.

I am showing no further questions at this time. I would like to turn the floor back to Mr. Nutter for any further or closing comments.

Thank you, Jackie. We appreciate all of your time today. I want to stress that I'm confident in our future. And I hope you sense that. I want to thank all the Haemonetics team for their commitment and energy to driving shareholder value. As a reminder, our Q4 call and year-end conference call is scheduled for May 6th, and we'll look forward to speaking with you then. Thanks so much. Take care.

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time, and have a wonderful day.