Haemonetics Corp (HAE) 2006 Q3 法說會逐字稿

Good morning, ladies and gentlemen. Welcome to the Haemonetics' third-quarter fiscal-year 2006 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 materially differ from the 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. Brad Nutter, Haemonetics' President and CEO, will moderate this call. Mr. Nutter, you may begin.

Thank you, operator. Good morning, everyone, and thanks for joining our Q3 call. Today, I am joined by Ron Ryan, our CFO; Lisa Lopez, General Counsel and VP of Administration; Julie Fallon, Director of Investor Relations; and Brian Concannon, President of our Patient Division.

Out call today will cover three things. First, I will comment on the Company's overall performance as well as FY '06 guidance. Second, Ron Ryan will detail our operating results. Third, Brian Concannon will discuss progress in the Patient Division. More specifically, he will comment on our great success with the OrthoPAT conversion and on our new product launches. I will end with some closing comments.

The third-quarter net income reflects two unusual events. The first event had a positive impact. As you may remember, for more than a year, we were in litigation with Baxter concerning a contract with a large Haemonetics customer, Alpha Therapeutics. When Baxter purchased Alpha, it refused to honor our supply contract, so we entered arbitration.

We reported last quarter that we won our lawsuit, and this was a great win. We received the cash during the third quarter and recorded it as $28 million in pretax income. The award represents $0.61 of earnings per share in the quarter.

The second unusual event had a negative impact on our P&L. During the quarter, we wrote off $3.8 million for an impaired asset related to pathogen reduction. In financial terms, our analysis of the future cash flows reflect a medium-term preference for bacterial detection over pathogen reduction. Accordingly, the expected cash flows no longer support the carrying value of this asset, and therefore we recorded the impairment charge.

Now to be clear, we continued to develop platelet collection technology for the pathogen reduction market. But from an accounting standpoint it was necessary to take this charge. The charge increased our R&D expense by $3.8 million, which had a significant impact on operating income and negatively affected earnings per share by $0.09 for the quarter.

On our website at www.Haemonetics.com, there is a page titled Q3 Reconciliation of Unusual Items. The page is a summary P&L with reported results and results excluding unusual items.

Now in our conference calls over the last three years, we have used a particular format to describe our business, strategies, and performance. Today, we're going to depart from that format and attempt to give you more clarity on our performance for the quarter, our projected performance for the year, and partial visibility into FY '07. Given the unusual items we talked about, we hope this different approach is helpful.

So let me start by identifying how we expect to finish FY '06. We expect to complete the year with earnings per share in the range of $2.44 to $2.51. Now, this is up significantly in from guidance at the beginning of the year and includes the Baxter award.

Moving up the P&L, we expect operating income will increase about 20% over prior year. This guidance is unchanged. We expect both gross margin and operating margin to improve over prior year. Again, this guidance is unchanged.

We are, however, changing our expected FY '06 sales finish. Now that we have better visibility into the impact of going direct on U.S. OrthoPAT, we're targeting total sales growth for the year at 8% to 10%. Our previous guidance has been growth of 11% to 13%.

Now, you might ask -- what has changed? The answer is very, very simple. Going direct on OrthoPAT cost us $2 million in sales this quarter and has already cost us almost $5 million in sales on a year-to-date basis. However, Brian Concannon will share going direct is strategic. It will have a tremendous positive impact on both our long-term sales growth and on gross profit margins.

So while this change will negatively impact our annual sales, you will see gross margins for U.S. OrthoPAT business go from about 50% to more than 70%; and Brian will give you more detail on this.

So the bottom line in terms of where we expect to finish by year end is slightly lower sales growth but continued outstanding leverage on our P&L with operating income growth of about 20%. Now let's dig into the P&L a little bit more, and I will turn the call over to Ron Ryan to do that.

But before I do, I would like to recognize Ron, who has announced his planned retirement from Haemonetics as our CFO. I want to thank Ron for his outstanding leadership during the last eight years and particularly the last three years that we've had a chance to work together.

Now at the risk of embarrassing Ron, he is 64; and frankly, I hope I look that good when I reach 64. He has built a very strong financial organization, guided us through SOX 404, helped strengthen our balance sheet, and provided great direction on our Corporation.

I am particularly thankful that he's willing to stay with our team put his personal retirement plans on hold for a time so that, number one, he can ensure a smooth transition to the new CFO and, number two and just as important, he can provide executive leadership as we launch our ERP program.

Now, ERP is an Enterprise Resource Planning system. It will be a key initiative for our future. Many of you have asked whether our corporate strategy of leveraging the P&L to improve profitability is sustainable. Well, yes it is. During the last eight years, we have reduced manufacturing and business costs by more than $30 million.

But to continue to leverage the P&L, we need to become a Company that is more sophisticated in resource planning and implementation. An ERP system will change the way we run our business. We can improve efficiency and effectiveness, and simultaneously leverage our P&L beyond just manufacturing.

Ron will lead the beginning stages of this implementation. With that, I will turn the call over to Ron Ryan.

Thanks, Brad, and good morning, everyone. After eight great years at Haemonetics I have seen this Company grow and change in many ways, and now I am committed to a smooth transition. I am excited about working with my successor as well as on launching the ERP process that Brad just described.

That is enough about me; let's turn to how our business performed. It was a good quarter. Today I am going to talk about the key revenue drivers by division, then I will cover the rest of the P&L.

For the Donor Division, third-quarter sales growth was driven by plasma and red cell disposables revenue. To give you an idea of the momentum that is building in our plasma business, in the first half of the year, revenue growth was 7.1%. In Q3 revenue growth expanded to 13.0%.

We have talked for some time about the glut of plasma in the marketplace. In the U.S. and Europe this glut has reduced significantly, and demand for plasma is back on the rise. The second phase of our conversion of ZLB to Haemonetics' systems is going well. So in FY '07, we will see the full benefits of the ZLB contract. Other U.S. plasma customers are growing as well. Therefore, plasma disposables revenue will be a significant growth driver in FY '07.

The other driver for Donor Division sales is red cells. Red cell disposables revenue grew 30.8% for the quarter, and 31.8% year-to-date. Of note in the quarter was that we had a strong rate of customer conversion to a higher-priced filtered disposables set. The red cell business is now of a size that its growth has an impact on our P&L. In FY '07 we're well positioned for another year of strong sales growth for this product, inasmuch as 95% of the U.S. market remains untapped. This positions us well into the future.

Now let me turn to blood bank disposables revenue which was down 1.3% for the quarter, and level on a year-to-date basis. This is because we are comparing against FY '05 when we launched [fluconazole], a generic drug. Filling the sales channels following this launch resulted in about $1 million of revenue in Q3 of FY '05. This has a major impact on our Blood Bank business. At year end, we expect blood bank disposables sales will remain level with FY '05.

Now let me remind you that 90% of our Blood Bank business is platelet collection disposables. We do not anticipate growth in platelet collection worldwide. But our platelet business continues to be stable in Europe and Japan. Let me share, the data indicates that our market share in Europe exceeds 55%; in Japan exceeds 70%; and in the U.S. is less than 5%. So our opportunity for growth in FY '07 and beyond is to target the U.S. market.

Now let me turn to our Patient Division where disposables revenues declined 1.3% for the quarter and increased 2.4% for the year. As we reported in Q2, we elected to go direct on OrthoPAT sales in the U.S. This had a significant yet temporary drag on sales. Brian Concannon will follow me to update you on the conversion process; but let me share that we expect the Patient Division to conclude the year with a disposables sales increase of about 3% to 4% over prior year.

Although our biggest sales drivers were plasma and red cell disposables, it's worth mentioning other strong contributors. Equipment was up 23.3% for the quarter and 32.8% year-to-date. This growth comes from strong sales across all geographies and several product lines.

Miscellaneous and service was up 35.9% for the quarter and 45.1% year-to-date. Most of this growth is from our 5D Information Management division. 5D nearly doubled sales as it continued to provide information technology that penetrates the larger blood collection market.

Before I turn to the rest of the P&L, one last comment involves mix contributing to sales growth. In the quarter, revenue growth was 7.7%. Disposables pricing contributed 0.8% and volume contributed 10.8%. Conversely, mix impacted us by -5.5%, and foreign exchange impacted us by negative 0.9%. Year-to-date, revenue growth was 9.1%.

Now let's review gross margin. Gross margin for the quarter was 52.7%, down 10 basis points versus prior year, principally due to mix. In the quarter, structural manufacturing costs were reduced by $1.6 million. For the year, we are now targeting close to $5 million in structural cost reductions; that is $1 million more than our original goal for cost savings.

Over the last eight years, we've taken more than $30 million out of structural cost. I am looking forward to ERP efforts in FY '07 that will lay the foundation for continued improvements in our strategy to leverage our P&L.

A final comment on gross margin. While we expect our gross margin in Q4 will be level with Q3, our full-year gross margin will increase over prior year. Year-to-date, our margin has improved 150 basis points from 50.9% to 52.4%.

Now let's turn our attention to operating expenses. Previously, we talked about our plan to increase expenses beginning in Q3 of last year. We said our expenses as a percent of sales would increase more rapidly than in the past. We're investing back into the business.

Reported Q3 operating expenses have increased 11.6% over prior year, a significant part of which was the $3.8 million impairment charge. But the point it's important for me to make here is that our other expenses will not continue at this run rate. Let me highlight four expenses we have absorbed which will not repeat in Q4.

These are, first, significant R&D expenses on new products. Second, refurbishment expenses for PCS 2 machines for the plasma business. Third, onetime legal expenses. And fourth, onetime expenses to prepare the transition of OrthoPAT to direct sales.

Therefore, as we look forward to the fourth quarter, we expect operating expenses to be less than Q4 FY '05. As a matter-of-fact, excluding the impairment charge, Q3 expenses were about level with prior year. So we expect a great deal of leverage in the business in Q4. This is one of the reasons we are so confident in achieving our full-year targeted growth and operating income of about 20%.

Let me turn to operating income. Reported operating income was $15 million, down 2.2% from Q3 FY '05. Year to date, operating income is $49 million, up 10.5%. Operating margin for the quarter was 14.2%, down 140 basis points. Year-to-date, operating margin is up 20 basis points to 15.8%. As stated, the impairment charge is included in these numbers and had a significant impact on the quarter.

Below the line, specifically EPS, we recorded $28 million in pretax income from the Baxter litigation win. This represents $0.61 in earnings per share. So reported earnings per share for the quarter were $1.02, up 143%, and for the year $1.89, up 64.3%.

So let me finish my comments today with the balance sheet. Our balance sheet remains strong. The quarter delivered $7 million in operating cash flow, which we define as free cash after working capital and capital expenditures. For the year, we expect nearly $40 million in operating cash flow, excluding the nearly $30 million pretax cash we received in the lawsuit.

We also generated over $3 million from stock option exercises. We have a $229 million invested cash base and $39 million in short-term and long-term debt.

We have given you some visibility into our expected finish for FY '06, and I will just remind you that as a global business we are affected by foreign exchange. However, we run our business on reported results. We always include the impact of foreign exchange when we update our guidance. So to be very clear, all our projections include the effect of the strengthening dollar. We've also posted information about this on our website.

Now with that, let me turn the call over to Brian Concannon, President of our Patient Division, who has exciting news concerning OrthoPAT and new products.

Thanks, Ron. Good morning, everyone. I am going to talk about two things. First, our great success in converting OrthoPAT to direct sales in the United States; and second, new product launches. Let's start with the OrthoPAT.

There were four reasons we decided to go direct with the OrthoPAT System. First, our prior distributor failed to meet its contractual growth targets for the past two years. We saw our sales momentum declining. We believed that we could do a better job growing our business with our own sales force.

The second reason we decided to go direct is that our distribution agreement was exclusive. That exclusivity gave us access to only about one-third of the market. So by ending the agreement, we are now able to exploit the full $400 million-plus orthopedic market for surgical blood salvage.

The third reason we decided to go direct is that we are coming out with new products. Expanding our sales force so we can provide our customers with a total value proposition will enhance our growth opportunities. In other words, we want to control our sales channel so that we more aggressively drive future product offerings with an expanded marketing effort. This will ensure our success.

Finally, and most important, by going direct we will improve OrthoPAT gross margins significantly. Going through a distributor, our gross margins were approximately 50%. We are now providing our customers with greater value and improving our margins to more than 70%.

Now, we knew going direct had risks. As expected, this change put a drag on our third-quarter sales results. In fact, we saw a $2 million negative impact on sales in the quarter when our distributor canceled its standing orders. Let me put that into a broader perspective. That $2 million of negative impact to sales is about 10% of the total Patient Division sales in the quarter. On a year-to-date basis, this will negatively affect the Patient Division's planned results by almost $5 million.

You should not be alarmed by this. Let me give you the facts as to why. Only 224 accounts represented 90% of our total OrthoPAT sales volume in the U.S. Of these 224 accounts, we have now secured 154 of them with newly signed long-term contracts that are exclusive and direct with Haemonetics.

Let me share another fact with you. In FY '05, we sold approximately 50,000 OrthoPAT disks through our distributor. Today, with these contracts, we have now secured almost 44,000 disks on a direct basis. Said another way, we have nearly 90% of our FY '05 unit volume now under contract with Haemonetics.

So our first order of business was to make sure we had secured our base business. Now we will position ourselves for growth in Q4 and FY '07. I will talk about FY '07 in just a minute, but first let's turn to what is really important, the impact on gross profit.

Remember, I said we secured almost 90% of our existing U.S. OrthoPAT base. You will also remember that our U.S. margins are moving from 50% to more than 70%. In Q4, the net effect of this conversion is that we will generate more than 69% more gross profit dollars than if we had retained 100% of the PAT business generated to our distributor.

To put it another way, in Q4, because of the improved profitability, our gross profit dollars will increase on this base of business by more than $1 million. This change was an outstanding opportunity, now realized, to improve the U.S. OrthoPAT profitability.

Now let's talk about the longer term. If we look at FY '07, we believe our base of business will be hugely and positively affected by this decision. First, most of our sales are in the United States and therefore not affected by foreign exchange. Second, we expect our U.S. sales will double, up from about 13 million this year.

Now this is really important. Our improved profitability positions us very well to invest in new product launches and more people, so that the entire Patient Division strategy can be realized in FY '07. In short, we will continue to invest in the business so that we can provide our customers with the broadest focus on blood management in the hospital industry. We are a blood management company, the best in the industry.

Now, some of you may ask about the remaining OrthoPAT customers who have not signed on with Haemonetics. Let me address that. To retain that business in some cases could be costly. So we have decided on a three-pronged strategy to ensure we achieve higher growth rates. First, we are going to work with existing customers who are using up inventory provided by our former distributor. As early as possible, we will switch them to Haemonetics brand. We hope to ramp up to existing run rates and grow their usage per machine.

Second, we will further penetrate hospitals that are currently using the OrthoPAT by expanding to orthopedic surgeons who are not yet using the device in their practice. This is a significant opportunity for us.

Third, we will identify our opportunities with existing Cell Saver customers. By working with hospitals that are already using surgical blood salvage devices and placing an emphasis on total blood management, we can expand our business in FY '07.

Finally, later in FY '07 as our product portfolio broadens, we will target customers interested in total blood management as a value proposition. Our experience over the last 120 days has validated what we said earlier, that the OrthoPAT is a blood product, not an orthopedic product.

So with that, let me turn to how we are progressing in our new product launches. In short, we are making good progress. CardioPAT is a blood salvage device for cardiovascular patients at high risk for postoperative transfusion. The FDA has approved our product enhancements. We're backing customer acceptance trials, and the trials are going well. We expect to reach full market release early in FY '07.

The next product in our launch queue is SmartSuction. This product clears the surgical field rapidly, but without excessive force that can damage tissue and red cells. That is why we call the product SmartSuction. The first product we will introduce in the SmartSuction family is the HARMONY. It can be used with our flagship Cell Saver brand systems as well as with the OrthoPAT and CardioPAT.

Customer acceptance trials for the HARMONY were finished in Q3. In early January, the system entered limited market release in give territories in the United States and four European countries. All in all, we are right on track and on budget.

Let me remind you of a product we introduced in Q4 of last year, the Cell Saver 5+. This is an improved version of the Cell Saver brand product line where we have been so successful for many years. We're projecting nearly $5.5 million in sales this year from the Cell Saver 5+.

Now Brad has talked a lot about learning how to launch new products, and while we didn't hit on all cylinders on all product launches, the 5.5 million in sales for the Cell Saver 5+ exceeded our expectations.

I would like to add just one other perspective. We're getting better disciplined on launching new products, and that makes me feel good about FY '07. In fact, the experience that has been most instructive has been the last 120 days with the OrthoPAT. Make no mistake, going direct on OrthoPAT was the equivalent of a new product launch. We really had to learn how to launch, market, and sell this product direct, and we have done one heck of a job. We have learned a lot about the process and discipline necessary for success, and that positions us well for our future.

So now, let me turn the call back to Brad.

Brian, thanks for the update and for the great work you and your team are doing to realize the full potential of OrthoPAT. This is an exciting growth vehicle.

I want to close with a few comments on Q3 and our expected finish for FY '06. There are a lot of moving parts on our P&L this quarter. Yet when we exclude the onetime items it was a good quarter. There is no getting around the short-term impact of going direct on OrthoPAT. But despite the $2 million negative impact on OrthoPAT, Q3 reported sales were up 7.7%.

Let me also comment on the plasma market. We report on disposable sales, but another story behind plasma growth is machine placements. By the end of the fiscal year, we will have installed almost 2,900 additional machines in the United States market. That will be in addition to an installed base of 3,153 machines at the end of fiscal-year '05. That is more than a 90% increase in machine placements this year alone. In FY '07 we plan to place an additional 800 devices.

So we have seen tremendous growth in demand for devices, and this will have a positive impact on disposable usage in FY '07 and beyond.

Red cell disposables sales continued to perform well. We also performed well in our equipment and miscellaneous lines. So by year end, both gross and operating margins will improve over prior year. Earnings per share are expected to be in the range of $2.44 to $2.51. This includes the arbitration award and impairment charges in the last two quarters. Excluding the benefit of the arbitration award, we will still exceed our original earnings estimates from the beginning of the year.

One last comment on Q4 projected finish. Now, here is a bridge from Q3 to Q4. We're very confident in our Q4 projected performance for two reasons. First, we will see strong incremental sales of OrthoPAT, plasma, and red cells. Second, we will manage expenses to be lower than last year. As I have said before, expenses are the most controllable line on the P&L; or said another way, we have very detailed plans in place to leverage the P&L in Q4.

So the bottom line is this. We are confident in the earnings power of this business. As such, by year end we expect operating income growth of about 20% on sales growth of 8% to 10%. Now that is the positive drop-through that you have come to expect from your Company.

So let me close by thanking Haemonetics' employees for another solid quarter. We're proud of our accomplishments and confident in our direction and expected performance for the year. Strategically and operationally, we are better positioned today than we have been in the three years I have been with Haemonetics. With that, operator, I will open up the call to your questions.

(OPERATOR INSTRUCTIONS) Steve Hamill, Piper Jaffray.

First, I was wondering. I just wanted to get clarification on the PCS numbers that I think you gave there at the end, Brad, in terms of 2,900 you will have installed during fiscal year '06. That includes the last phase of the ZLB transition?

That is correct, Steve.

So then the 800 you are expecting in fiscal-year '07 is that again for ZLB, or is that additional customers?

That is the entire marketplace, Steve, so inclusive of ZLB plus others.

Okay.

So we are really seeing some tremendous growth in demand for the devices, which poses a great opportunity for next year's growth.

Roughly how many did you place with ZLB back in April? Do you remember?

In April, it was -- in Q1 and 2 it was around 700.

Okay, so it sounds like it is pretty much -- ZLB is going to be pretty much in line with what you told us on the last conference call.

That's correct.

Okay. Then my second question is with regard to the surgical business. I was wondering if Brian could talk a little bit about the hiring there. What are your plans for that business, sales and marketing-wise?

Sure Steve. We have, as we had told you previously, we were expanding from our original 13 territories to 12 specialist territories focused on the OrthoPAT. Those are complete. Those people have been trained and they are operational and in their territories today. We will be hiring another six in Q1 of FY '07.

So you will have a total of -- that would be 31 then?

31 resources, yes.

Okay. Great. Thank you.

David Zimbalist of Natexis.

I am wondering if you could talk a little bit about how you talked about fourth-quarter gross margins being roughly in line with the third quarter. And yet, it sounds like the impact from OrthoPAT will be more positive in the fourth quarter than in the third quarter. You will have more direct sales as a percentage of your sales, which should actually bring it up.

Could you talk a little bit about with that trade-off is there? And what the implications of that might be for 2007?

Yes, David this is Brad. We're going to see a slight mix shift in Q4 as Brian indicated. We will see strong improvements in OrthoPAT margin from 50 to 70%. That will be slightly offset by margin in plasma. I would ask Ron to comment as well.

Yes, just to further elaborate on margins, as I mentioned our margins are now starting to reflect the change in the business mix due to the strong growth in plasma. Some of you will recall that our gross margin in the plasma business is somewhat lower than the other products; although, because it involves less direct spending, our operating margins are quite acceptable in that business.

So as plasma continues to grow, that has had some drag on gross margins. However, the OrthoPAT will be helpful. Just a couple of other points on margin, we were pleased in the quarter that we had about $800,000 of favorable pricing. We had about $1.6 million as I mentioned in structural cost reductions. So all of these are giving good lift to our gross profitability.

And for -- your interest income is also up pretty sharply in the quarter. Is that something that we should see going forward as well?

Yes, for the time being. The interest income pickup is certainly a factor of the higher level of cash generated in the quarter, and also the rising interest rates. Our cash is basically invested in tax-exempt instruments, and those short-term rates have been rising in the market.

I will get back in line.

James Sidoti of Sidoti & Company.

I was wondering, I know you probably don't want to get into too much detail for fiscal 2007 on this call, but can you at least give us some sense on where you think the gross margin will be going next year? Considering the fact that currency no longer will be a tailwind but actually start to work against you; and you will have an increased mix shift towards plasma.

As you know, Jim, we give guidance at the end of our Q4, and we intend to do that in May, on our May call. But generally speaking, because of the slight mix shift, we would anticipate that our margins would be more flat versus the high increase in margins that we have seen over the last three years.

As you know over the last three years, our gross margins have gone from 46% to more than 52%. So we have seen that in the last three years. We anticipate as we finalize our plans we can give you more specifics, but they will be more flattish in FY '07 because of that mix shift.

So you think somewhere in the low 50s is reasonable?

In that range.

Then as a follow-up, you brought up ERP. I have seen other companies try, implement ERP in the past, and that could have a near-term negative impact on margins. Do you expect something similar to happen in Haemonetics because of the implementation of ERP?

The answer simply is we hope not. One of the things that I am very pleased with is that as Ron decided to retire, he has also decided to really help us in the first implementation phases of ERP. After his eight great years here, he has tremendous resources that he can bring and tremendous leadership to the beginning of that process.

My background in other companies where I put in new ERP systems in the past indicates that the key to success is having an incredibly senior leader take charge of this process and get us started in the right way. In the absence of that, sometimes ERP systems can go woefully poorly.

It's all about execution, focus, and keeping on top of the details. I think if you look at our operating results over the last three years, you have seen that disciplined focus approach every quarter, quarter after quarter, and our results indicate that. Ron's leadership, frankly, in moving from his position as CFO into helping us in the first phases of ERP is really geared towards getting us to have a great start at the ERP implementation.

I have confidence in his leadership and abilities, and I think we will not have the negative impacts that you hear so many times companies have because it's a lack of leadership. And we have a great leader in Ron leading that effort for us.

Okay, and then I am going to cheat and ask one more. Can you just remind me, what is a good tax rate going forward?

Our underlying tax rate, Jim, right now, is about 35.25%. It's come down a little bit because we have a higher proportion in our pretax income of interest from tax-exempt securities.

Okay, so as we look out into '07 and beyond, that is a good number to use.

That is our current run rate if you take out all the puts and takes every quarter.

And since you asked three questions, you get one next time around, Jim.

All right.

John Putnam of the Stanford Group.

I was wondering if you might elaborate a little bit on CardioPAT and what your expectations are for the product in the fourth quarter, and then going into next year. Are you going to have to ramp up the marketing on this, the sales and marketing on this, a whole lot? Can you just give us some color on that, Brad?

Sure, I will turn it over to Brian. He has been very much involved with this. Brian?

John, in terms of what we are going to have to ramp up, no, our focus is going to be very much the same as it was originally. We had the initial customer acceptance trials put off because of the change we needed to make to the product. But frankly, our expectations for the product in fiscal year '07 are not changed.

In fact, I believe that the change with the OrthoPAT now positions our U.S. selling organization much like the rest of the world, to be able to represent a total value proposition with all of our cell salvage devices, in a way that brings the greatest benefit to our customers. So I think we are better positioned than in the past.

So you won't need to add any sales folks?

No, the sales folks that we are adding, while there is initial focus on the OrthoPAT, will automatically transfer into perioperative autotransfusion, which is where the OrthoPAT focuses and, frankly, to a total blood management value proposition.

John, this is Brad. I think that is the key point here. Let's remember that what we have learned as we have gone direct with OrthoPAT is that we're a very good blood company. And Brian has positioned the Patient Division as the blood management expert within the hospital operating room space.

So we are very confident that as he continues to build his sales force as he has done with OrthoPAT, that our folks can do a good job of representing that total value proposition that Brian talks about.

Okay, a follow-up on the Red Cell business. One of the data points was the 95% unpenetrated market. Can you give us some feel for how you are penetrating that market, how quickly, and what you're doing to continue to convert that market?

You bet. As Brian talks about, the fast right of growth in converting on OrthoPAT direct to Haemonetics, one of the things I have learned in 30 years of being in the healthcare business is, in the hospital marketplace, people take technology and new products and ramp up more quickly than in the blood bank area. There are a variety of good reasons for that.

Therefore, the red cell market is one which has been slow to develop for a variety of reasons. Yet over the last couple of years, we continue to grow north of 30% per year. Now as Ron indicated in his prepared comments, that is a business that has enough size and scope to it that that 30% increase is having a significant impact on our top-line growth.

So we expect to continue to penetrate that market rapidly. We think it's a good market. It is very underpenetrated. For those of you that may be new to the Haemonetics story, really what we're doing is converting whole blood collection to this new technology.

There are a number of advantages for the customers in doing that, and Pete Allen and the Donor Division team can report on our progress there at a future conference call. But we expect this to be continued growth vehicle for us going forward.

Thanks very much.

(OPERATOR INSTRUCTIONS) David Zimbalist of Natexis.

Can you talk a little bit more about your ERP implementation? How much of it is already sort of in-process or in the planning stages? And at what point you start to encounter the upfront costs of the implementation?

It's all in the planning stages at this point. We have begun no implementation to date. Our ramp up for start is looking at about the Q2 time frame of next year.

As we develop our annual operating plan, which we will share with you in the May time frame for next year, we will be able to give you a lot more specifics as to what the exact dollars look like for FY '07.

So right now we are in the total planning process, and that is part of the role that Ron will have in helping us think through financially and from an AOP planning or annual operating plan what our numbers will look like as we go forward.

Great. Second, can you talk a little bit about the right level of R&D spending? You're running this year basically $5.5 to $6 million a quarter, excluding any onetime writedowns. So is that the right kind of level going forward? Or do you expect that your R&D spending actually would be rising along with your total level of sales?

At this point in time we are comfortable with that level of R&D spend. As you know, we have looked at our second strategy, which is to expand the business, and we can do that through marketing partnerships, acquisitions, or R&D. So given that there are three ways to expand a business and approach that strategy, we are comfortable with our R&D spend at this point in time.

Thanks.

Steve Hamill of Piper Jaffray.

Yes, I was wondering on the platelet business, at what point -- or blood bank business I should say. At what point will you anniversary these prior quarters where you had the significant pharmaceutical revenue?

Those quarters are behind us at this point.

Okay, and are there additional opportunities like this in the future? This is something you guys really haven't talked much about.

There may be. As you know, Steve, we have a plant in Union, South Carolina, that makes these generic drugs. It is a business that we purchased a number of years ago. I would ask Lisa to comment on how this came as part of our business to really support the red cell business. But we think there may be some growth potential in that in the future, in converting over to generics. Lisa?

This was a purchase almost 10 years ago in order to secure access to drugs that we would need to supply to our red cell customers. It has gone well, it has served that purpose. It was really a strategic purpose, but we are examining ways in which to leverage the capacity in that plant, perhaps, to offer different [clients] drugs going forward. And that is what fluconazole represented about a year ago.

But that was just a limited opportunity then, I take it?

That's right.

I guess, along those same lines, I would like to bring Brad back to the question of uses of cash, given another strong quarter for cash flow. I would love to get your thoughts on that in terms of the year ahead.

Yes, thanks, Steve. We have spent the last three years working awfully hard to make sure that we have a very strong cash position. I would say that when I look at the Company today, we have accomplished that objective; and we are pleased and proud of results.

Given that, as we look at strategy number two, how we intend to expand the business, again as I have indicated we can do that through internal R&D, which we are doing. We can do it through marketing partnerships, which we have done. And we're also capable today with that cash of looking at acquisitions to continue to change the growth profile of our Company or of your Company.

So basically we continue to look at possible acquisitions. We're being very mindful that we have a financial model that is very disciplined in the kind of companies that we would bring into or assets that we would bring into our Company. So we're been very cautious on that, yet very disciplined.

We have looked, in the tenure of almost three years that I have been with the Company, of more than 30 possible acquisitions or additions to our business. As you know, we have done a couple. One, it's a bloodstream product that Brian talked about; and the other is the equity position we have taken in [ERICs] as a great use of cash. So we continue to be pleased with finding the right kinds of things to look for, and we would use cash in that way.

Is there any sort of -- deadline is probably a harsh term, but I don't know what else to use -- deadline that you have in your mind, in terms of how long you continue to look for those external opportunities before the cash balance gets large enough that you feel that you need to do something in the way of either buybacks or dividends?

Not this point, Steve, to be direct. I think we continue to look at a number of different things. We have expanded our field of use with ERICs and spent $3 million on that recently.

So this is a business that for three years in a row has grown operating income more than 20%, and we are projecting approximately about 20% growth in operating income this year. We think that is a pretty good model. We think that we have generated good cash. We are improving margins, both gross and operating.

So this is a Company that is operated well. I just don't want to get to a point of buying something just to buy it for no particular reason. You have to be strategic. I would remind those of you that have known me over the years that, having been part of American Hospital Supply when Baxter and American emerged, and then nine years after that merger every asset has been sold out of Baxter that was -- and I am partially one of the persons responsible -- a failure from a strategic standpoint.

So rather than feeling the pressure just to buy something, I would rather buy something that continues to create the shareholder value that we have promised our shareholders on a consistent long-term basis. I think that is responsible leadership, and that would be the way we will go foward, versus trying to put a time limit on what we're going to do with our cash. I think our shareholders expect that out of this leadership team, to be that disciplined.

At this time there are no more questions. I would like to turn the floor back over to Mr. Nutter for any closing remarks.

Thank you, operator. I hope you get a sense of how confident that we are in the earnings power of this business. As such, by year end we expect operating income growth of about 20% for the third year in a row. We will have sales growth of about 8% to 10%. And that is the positive drop-through that we have consistently talk about for the last three years for your Company.

I indicated in my prepared remarks that I have never been more pleased that, both strategically and operationally, we're better positioned than we have been in the three years that I have been with this Company. I think this quarter is an indication of the strong operating discipline and the strong operating management of this team.

So we look forward to talking with you and sharing our outstanding results as we finish Q4 in early May and share our annual operating plan and strategy going forward. Thanks so much.

Thank you. This concludes today's teleconference. You may now disconnect your lines.